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Discounting pension liabilities: funding versus value*

Published online by Cambridge University Press:  10 June 2016

JEFFREY R. BROWN  and
GEORGE G. PENNACCHI
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)
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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.

Keywords

G23H75Pension liabilitiesdiscount ratecost of living adjustments
Type
Articles
Information
Journal of Pension Economics & Finance , Volume 15 , Special Issue 3: The Impact of Reforms of State Retirement Plans , July 2016 , pp. 254 - 284
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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