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A risk-based model for the valuation of pension insurance

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  • Chen, An

Abstract

In the US, defined benefit plans are insured by the Pension Benefit Guaranty Corporation (PBGC). Taking account of the fact that the PBGC covers only the residual deficits of the pension fund the sponsoring company is unable to cover and that the plans can be prematurely terminated, we consider a model that accounts for the joint dynamics of the pension fund’s and sponsoring firm’s assets in order to effectively determine the risk-based pension premium for the insurance provided by the PBGC. We obtain a closed-form pricing formula for this risk-based premium. Its magnitude depends highly on the investment portfolio of the pension fund and of the sponsoring company as well as the correlation between these two portfolios.

Suggested Citation

  • Chen, An, 2011. "A risk-based model for the valuation of pension insurance," Insurance: Mathematics and Economics, Elsevier, vol. 49(3), pages 401-409.
    • Handle: RePEc:eee:insuma:v:49:y:2011:i:3:p:401-409
    DOI: 10.1016/j.insmatheco.2011.06.002
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    References listed on IDEAS

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    1. Jeremy I. Bulow & Randall Morck & Lawrence H. Summers, 1987. "How Does the Market Value Unfunded Pension Liabilities?," NBER Chapters, in: Issues in Pension Economics, pages 81-110, National Bureau of Economic Research, Inc.
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    12. Broeders, Dirk & Chen, An, 2010. "Pension regulation and the market value of pension liabilities: A contingent claims analysis using Parisian options," Journal of Banking & Finance, Elsevier, vol. 34(6), pages 1201-1214, June.
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    Cited by:

    1. Romaniuk, Katarzyna, 2019. "Premiums of the Pension Benefit Guarantee Corporation and risk-taking by pension plans," The Quarterly Review of Economics and Finance, Elsevier, vol. 74(C), pages 301-307.
    2. Chen, An & Uzelac, Filip, 2014. "A risk-based premium: What does it mean for DB plan sponsors?," Insurance: Mathematics and Economics, Elsevier, vol. 54(C), pages 1-11.
    3. Dirk Broeders & An Chen & Birgit Koos, 2014. "Utility-equivalence of pension security mechanisms," DNB Working Papers 414, Netherlands Central Bank, Research Department.
    4. Qian, Linyi & Shen, Yang & Wang, Wei & Yang, Zhixin, 2019. "Valuation of risk-based premium of DB pension plan with terminations," Insurance: Mathematics and Economics, Elsevier, vol. 86(C), pages 51-63.

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    More about this item

    Keywords

    Pension insurance; PBGC; Defined benefit plan; Correlation; Sponsor support;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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