Discounting Pension Liabilities: Funding Versus Value

51 Pages Posted: 15 Jun 2015

See all articles by Jeffrey R. Brown

Jeffrey R. Brown

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); University of Illinois College of Law; University of Illinois at Urbana-Champaign - Institute of Government and Public Affairs (IGPA); University of Illinois at Urbana-Champaign - Department of Economics

George Pennacchi

University of Illinois

Date Written: June 2015

Abstract

We argue that the appropriate discount rate for pension liabilities depends on the objective. In particular, if the objective is to measure pension under- or over- funding, a default-free discount rate should always be used, even if the liabilities are themselves not default-free. If, instead, the objective is to determine the market value of pension benefits, then it is appropriate that discount rates incorporate default risk. We also discuss the choice of a default-free discount rate. Finally, we show how cost-of-living adjustments (COLAs) that are common in public pensions can be accounted for and valued in this framework.

Suggested Citation

Brown, Jeffrey R. and Pennacchi, George G., Discounting Pension Liabilities: Funding Versus Value (June 2015). NBER Working Paper No. w21276, Available at SSRN: https://ssrn.com/abstract=2618664

Jeffrey R. Brown (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

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National Bureau of Economic Research (NBER) ( email )

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University of Illinois College of Law ( email )

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University of Illinois at Urbana-Champaign - Institute of Government and Public Affairs (IGPA) ( email )

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George G. Pennacchi

University of Illinois ( email )

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