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Discounting pension liabilities: funding versus value*

Published online by Cambridge University Press:  10 June 2016

JEFFREY R. BROWN
Affiliation:
University of Illinois and NBER (e-mail: brownjr@illinois.edu)
GEORGE G. PENNACCHI
Affiliation:
University of Illinois (e-mail: gpennacc@illinois.edu)

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 overfunding, 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 that are common in public pensions can be accounted for and valued in this framework.

Type
Articles
Copyright
Copyright © Cambridge University Press 2016 

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Footnotes

*

We thank Editor Robert Clark, Joshua Rauh, Olivia Mitchell, and participants in the 2015 NBER Conference on Retirement and Health Benefits in the Public Sector for helpful feedback and suggestions.

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