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Joint risk of DB pension underfunding and sponsor termination: incorporating option-based projections and valuations into PIMS*

Published online by Cambridge University Press:  08 April 2015

DEBORAH LUCAS*
Affiliation:
Sloan School of Management, Massachusetts Institute of Technology, 100 Main Street, E62-640, Cambridge, MA 02142-1347, USA (e-mail: dlucas@mit.edu)

Abstract

When a private pension plan sponsor with an underfunded plan becomes insolvent, the difference between the value of the plan's assets and its termination liabilities represents a liability for the Pension Benefit Guaranty Corporation (PBGC). Hence, accurately modeling the joint statistical distribution over time of defined benefit pension underfunding and sponsor terminations is critical for estimating PBGC's prospective cash flows and evaluating its financial position. It appears that the current Pension Insurance Modeling System (PIMS) approach to modeling risk does a reasonable job of capturing its statistical properties effects on PBGC cash flows, although some of the aspects might be improved, and metrics expanded. The present paper outlines, how an option-based approach to modeling the joint distribution of defaults and underfunding in PIMS might be implemented, while preserving the strengths of the current model. Moving to an option-based approach would allow PIMS to be used to estimate the fair values of future liabilities. Such an approach could have a significant effect on the perceived financial position of PBGC.

Type
Articles
Copyright
Copyright © Cambridge University Press 2015 

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Footnotes

*

The research reported herein was pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement Research Consortium (RRC); the author also acknowledges support from The Pension Research Council at The Wharton School. All findings and conclusions expressed are solely those of the author and do not represent the views of the SSA or any agency of the federal government, the MRRC, the PRC, or The Wharton School at the University of Pennsylvania.

References

Congressional Budget Office (CBO) (2005). The Risk Exposure of the Pension Benefit Guarantee Corporation. CBO Study. Washington, DC: CBO.Google Scholar
Crosbie, P. and Bohn, J. (2003). Modeling Default Risk. Moody's KMV. Available online at http://business.illinois.edu/gpennacc/MoodysKMV.pdfGoogle Scholar
Hsieh, S.-J., Chen, A. H. and Ferris, K. R. (1994). The valuation of PBGC insurance using an option pricing model. Journal of Financial and Quantitative Analysis, 29: 8999.CrossRefGoogle Scholar
Lucas, D. (2012). Valuation of Government Policies and Projects. Annual Review of Financial Economics, 4(6): 120.CrossRefGoogle Scholar
Marcus, A. (1987). Corporate pension policy and the value of PBGC insurance. In Bodie, Z., Shoven, J. and Wise, D. (eds), Issues in Pension Economics. Chicago, IL: University of Chicago Press, pp. 4980.Google Scholar
Pennacchi, G. G. and Lewis, C. M. (1994). The value of pension benefit guaranty corporation insurance. Journal of Money, Credit and Banking, 26(3): 735753.CrossRefGoogle Scholar
Pension Benefit Guarantee Corporation (PBGC) (2009). Pension Insurance Modeling System PIMS System Description for PIMS SOA ‘Core’ (vFY09.1). Washington, DC: PBGC.Google Scholar
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