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A risk-based model for the valuation of pension insurance

  • Chen, An
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    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.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0167668711000758
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    Article provided by Elsevier in its journal Insurance: Mathematics and Economics.

    Volume (Year): 49 (2011)
    Issue (Month): 3 ()
    Pages: 401-409

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    Handle: RePEc:eee:insuma:v:49:y:2011:i:3:p:401-409
    DOI: 10.1016/j.insmatheco.2011.06.002
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505554

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    1. Fiona Stewart, 2007. "Benefit Security Pension Fund Guarantee Schemes," OECD Working Papers on Insurance and Private Pensions 5, OECD Publishing.
    2. 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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    4. Jin, Li & Merton, Robert C. & Bodie, Zvi, 2006. "Do a firm's equity returns reflect the risk of its pension plan?," Journal of Financial Economics, Elsevier, vol. 81(1), pages 1-26, July.
    5. Pennacchi, George G & Lewis, Christopher M, 1994. "The Value of Pension Benefit Guaranty Corporation Insurance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(3), pages 735-53, August.
    6. Feldstein, Martin & Seligman, Stephanie, 1981. "Pension Funding, Share Prices, and National Savings," Journal of Finance, American Finance Association, vol. 36(4), pages 801-24, September.
    7. Alan J. Marcus, 1983. "Corporate Pension Policy and the Value of PBGC Insurance," NBER Working Papers 1217, National Bureau of Economic Research, Inc.
    8. Jeffrey R. Brown, 2008. "Guaranteed Trouble: The Economic Effects of the Pension Benefit Guaranty Corporation," Journal of Economic Perspectives, American Economic Association, vol. 22(1), pages 177-198, Winter.
    9. Sharpe, William F., 1976. "Corporate pension funding policy," Journal of Financial Economics, Elsevier, vol. 3(3), pages 183-193, June.
    10. Jeremy I. Bulow & Randall Morck & Lawrence H. Summers, 1985. "How Does the Market Value Unfunded Pension Liabilities?," NBER Working Papers 1602, National Bureau of Economic Research, Inc.
    11. Nielson, Norma L. & Chan, David K. W., 2007. "Private pensions and government guarantees: clues from Canada," Journal of Pension Economics and Finance, Cambridge University Press, vol. 6(01), pages 45-66, March.
    12. David W. Wilcox, 2006. "Reforming the Defined-Benefit Pension System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 37(1), pages 235-304.
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