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Financial Valuation of PBGC Insurance with Market‐Implied Default Probabilities

25 Pages Posted: 6 Oct 2013 Last revised: 31 Jan 2014

Jules H. van Binsbergen

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Robert Novy-Marx

Simon Business School, University of Rochester; National Bureau of Economic Research (NBER)

Joshua D. Rauh

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Abstract

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.

Keywords: pensions, pension benefit guaranty corporation, insurance valuation

JEL Classification: G22, G23, G28

Suggested Citation

van Binsbergen, Jules H. and Novy-Marx, Robert and Rauh, Joshua D., Financial Valuation of PBGC Insurance with Market‐Implied Default Probabilities. Simon School Working Paper No. FR 13-27. Available at SSRN: https://ssrn.com/abstract=2336304 or http://dx.doi.org/10.2139/ssrn.2336304

Jules H. Van Binsbergen

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://www.nber.org/people/jules_vanbinsbergen

Robert Novy-Marx

Simon Business School, University of Rochester ( email )

Rochester, NY 14627
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Joshua D. Rauh (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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