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Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities

In: Tax Policy and the Economy, Volume 28

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

Abstract

In this paper, we use financial valuation techniques to measure the unfunded liabilities associated with the Pension Benefit Guaranty Corporation (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 triggered 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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Suggested Citation

  • Jules H. van Binsbergen & Robert Novy-Marx & Joshua Rauh, 2014. "Financial Valuation of PBGC Insurance with Market-Implied Default Probabilities," NBER Chapters, in: Tax Policy and the Economy, Volume 28, pages 133-154, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberch:13053
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    References listed on IDEAS

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    1. Jeffrey R. Brown, 2008. "Guaranteed Trouble: The Economic Effects of the Pension Benefit Guaranty Corporation," Journal of Economic Perspectives, American Economic Association, vol. 22(1), pages 177-198, Winter.
    2. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
    3. Bodie, Zvi & Shoven, John B. & Wise, David A. (ed.), 1987. "Issues in Pension Economics," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226062846.
    4. Alan Marcus, 1987. "Corporate Pension Policy and the Value of PBGC Insurance," NBER Chapters, in: Issues in Pension Economics, pages 49-80, National Bureau of Economic Research, Inc.
    5. Treynor, Jack L, 1977. "The Principles of Corporate Pension Finance," Journal of Finance, American Finance Association, vol. 32(2), pages 627-638, May.
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    Cited by:

    1. Joshua D. Rauh, 2015. "Why City Pension Problems Have Not Improved, and a Roadmap Forward," Economics Working Papers 15101, Hoover Institution, Stanford University.

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