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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
DEBORAH LUCAS*
Affiliation:
Sloan School of Management, Massachusetts Institute of Technology, 100 Main Street, E62-640, Cambridge, MA 02142-1347, USA (e-mail: [email protected])
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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.

Keywords

H4H5G13fair valueoption-pricingpension guarantee valuation
Type
Articles
Information
Journal of Pension Economics & Finance , Volume 14 , Issue 2: Special Issue on Assessing the U.S. Pension Insurance Modeling System (PIMS) , April 2015 , pp. 172 - 185
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

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