Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities

Jules H. van Binsbergen, Robert Novy-Marx, Joshua Rauh

Chapter in NBER book Tax Policy and the Economy, Volume 28 (2014), Jeffrey R. Brown, editor (p. 133 - 154)
Conference held October 3, 2013
Published in October 2014 by University of Chicago Press
© 2014 by the National Bureau of Economic Research
in The Tax Policy and the Economy Series

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.

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Document Object Identifier (DOI): 10.1086/675590

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