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Discounting pension liabilities: funding versus value*

  • JEFFREY R. BROWN (a1) and GEORGE G. PENNACCHI (a2)
Abstract
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.

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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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References
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Journal of Pension Economics & Finance
  • ISSN: 1474-7472
  • EISSN: 1475-3022
  • URL: /core/journals/journal-of-pension-economics-and-finance
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