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Discounting pension liabilities: funding versus value*



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.



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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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