Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities
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In this paper, we use financial valuation techniques to measure the unfunded liabilities associated with the PBGC single-employer pension insurance program. This is an alternative approach to the calculations of expected future PBGC payouts in the PBGC Exposure Reports. The PBGC insurance is akin to an exchange option, a financial instrument that allows a party to exchange one risky asset for another. Calculating the value of this option for each PBGC-covered plan provides a measure of the fair market price of the PBGC guarantee that is consistent with the finance principles of risk-neutral pricing. That is, the market valuation method reflects the fact that bad outcomes tend to coincide with times when losses are particularly painful. The valuation we perform also reflects the fact that PBGC insurance is trigged only in the case of bankruptcy by drawing on the default-probabilities implied by the credit ratings of insured plans. Under the baseline parameters, the PBGC's insurance of the unfunded liabilities has a financial value of $358 billion, net of the estimated present value of PBGC premiums.
This research was supported by the U.S. Social Security Administration through grant #5RRC08098400-05-00 to the National Bureau of Economic Research as part of the SSA Retirement Research Consortium. The findings and conclusions expressed are solely those of the authors and do not represent the views of SSA, any agency of the Federal Government, or the NBER.
Since July 2012, I am a Professor of Finance at the Stanford Graduate School of Business and a Senior Fellow at the Hoover Institution. I receive some research funding from both Stanford GSB and Hoover, which I spend on the research topics of my choosing.
Between July 2009 and June 2012 I was an Associate Professor at the Kellogg School of Management at Northwestern University. Through the Kellogg and the Zell Center for Risk Research at Kellogg, I received a research budget which I spent on the research topics of my choosing.
In addition to my role as a faculty member, I have a few outside activities and affiliations. In the past three years I have:
(i) been a research associate and faculty research fellow of the National Bureau of Economic Research (NBER), a non-profit organization devoted to economic research.
(ii) been a research fellow of Netspar (Netherlands), a network aimed at connecting pension practice and pension science.
(iii) benefited from research funding from the Social Security Administration (SSA) through a grant to the National Bureau of Economic Research as part of the SSA Retirement Research Consortium.
(iv) periodically received standard speaking fees, consulting fees, or honoraria. During the last three years, I have received these types of fees from each of the following organizations: the Brookings Institution, Blue Cross Blue Shield of South Carolina, the Gerson Lehrman Group, Netspar, NBER, the New America Foundation, the Milken Institute, Stanford University, the Federal Reserve Bank of Atlanta, Cornerstone Research, Loyola Marymount University, and the Hoover Institution.