Present Value Of Liabilities Research Articles

Policy options for state pension systems and their impact on plan liabilities

AbstractWe calculate the present value of state pension liabilities under existing policies and separately under policy changes that would affect pension payouts. If promised payments are viewed as default free, then it is appropriate to use discount rates given by the Treasury yield curve. If plans are frozen at June 2009 levels, then the present value of liabilities would be $4.4 trillion. Under the typical actuarial method of recognizing future service and wage increases, this figure rises to $5.2 trillion. Compared to $1.8 trillion in pension fund assets, the baseline level of unfunded liabilities is therefore around $3 trillion. A 1 percentage point reduction in cost-of-living adjustments (COLAs) would lower total liabilities by 9–11%; implementing actuarially fair early retirement would reduce them by 2–5%; and increasing the retirement age by 1 year would reduce them by 2–4%. Dramatic policy changes, such as the elimination of COLAs or the implementation of Social Security retirement age parameters, would leave liabilities around $1.5 trillion more than plan assets. This suggests that taxpayers will bear the lion's share of the costs associated with the legacy liabilities of state DB pension plans.

Public Pension Promises: How Big are They and What are They Worth?

We calculate the present value of state employee pension liabilities as of June 2009 using discount rates that reflect the risk of the payments from a taxpayer perspective. If benefits have the same default and recovery characteristics as state general obligation debt, the national total of promised liabilities based on current salary and service is $3.20 trillion. If pensions have higher priority than state debt, the present value of liabilities is much larger. Using zero-coupon Treasury yields, which are default-free but contain other priced risks, promised liabilities are $4.43 trillion. Liabilities are even larger under broader concepts that account for projected salary growth and future service.

Real and Illusory Value Creation by Insurance Companies

INTRODUCTION One of the fundamental tenets of financial economics is that insurance companies, just as other financial and non-financial firms, have a very strong incentive to maximize current shareholder value. (1) This seemingly simple observation leads to a wide variety of managerial behavior. (2) In this article we will review a simple decomposition of the value of an insurance company. The decomposition illuminates the motivation for a variety of strategies that can be observed in practice. These strategies run the gamut from accounting manipulation through risk transfer schemes to positive present value (NPV) project selection. We will review these in some detail below. Then we will illustrate these techniques from our experience with every major U.S. life insurer insolvency since Baldwin United in 1984. COMPONENTS OF From VALUE The market value of insurance company owners' equity is defined as the difference between the market value of assets and the market value of liabilities. For purposes of valuation, it is helpful to partition more finely the components of equity value. In this section, we will partition the value of insurance company owners' equity, or stock in the case of a stock company, into its four major components: franchise value, market value of tangible assets, present value of liabilities, and put option value (see Figure 1). The first two of these components are clearly assets. The third component is related to liability value. The put option value can be treated as part of the liability value as a contra-liability or as an asset. We will discuss each component in turn. [FIGURE 1 OMITTED] The franchise value stems from what economists call quasi-rents. It is the present value of the quasi-rents that an insurer is expected to garner because it has scarce resources, scarce capital, charter value, licenses, a distribution network, personnel, reputation, and so forth. It includes renewal business. (3) Franchise value is dependent on firm insolvency risk. The less insolvency risk there is, the more likely the firm is to remain solvent long enough to capture all the available economic rents arising from its renewal business, its distribution network, its reputation, and so forth. (4) The market value of liabilities includes pricing of all contingencies within the insurance liabilities. In our decomposition we have elected to separate out the risk of the insurance company defaulting on its obligations. The risk of such a default is captured by the put option. Other contingencies, including such risks as interest rate contingencies, mortality contingencies, or equity market contingencies, are included in the present value of liabilities. Thus, the present value of liabilities is the present value of all promised liability cash flows discounted at Treasury rates rather than discounting at rates that would reflect the possibility of default. In the case of interest sensitive cash flows, it is the value of the Treasury security portfolio (including derivatives as needed) that fully defeases the liabilities with all non-default contingencies fully hedged. This quantity will be larger than the market value of liabilities where the promised liability cash flows are discounted at rates that reflect the risk of failure to make the promised cash flows. Merton (1974) initially observed that the value of a debt obligation could be expressed as the value of a default-risk free bond minus a put option. The put option represents the value to the issuer of the possibility of defaulting on the obligation. The same holds true for insurance liability obligations. The market value of liabilities can be expressed as the present value of liabilities minus the put option that represents the value to the issuer of potentially defaulting on the obligations. (5) The market value of tangible assets and the present value of liabilities can be netted together, producing what we will call net tangible value. …

Solvency requirements for pension annuities

This paper deals with solvency requirements for life annuities portfolios and funded pension plans. Particular emphasis is devoted to longevity risk, i.e. the risk arising from uncertainty in future mortality trends. This risk must be faced by insurance companies and pension plans that have guaranteed lifelong payoffs.Solvency is investigated referring to immediate annuities, and hence the so-called decumulation phase is addressed. To assess solvency, assets are compared with the random present value of liabilities. Several requirements are considered, each leading to a required asset level that must be financed both with premiums (or contributions) and capital allocation.

Rethinking Pension Liabilities and Asset Allocation

The objective of a defined-benefit pension fund9s asset allocation policy should be to fully fund accrued pension liabilities at the lowest cost to the plan sponsor, subject to sensible risk. A major risk plan sponsors face is that higher contributions will be required should the asset portfolio not be constructed properly. Specifically, the plan sponsor in establishing its asset allocation strategy should take into account both the present value of liabilities (cash flows) and the volatile behavior of the value of the liabilities due to changes in interest rates. While fluctuations in the present value of assets versus liabilities (funding ratios) represent high financial risk for all plan sponsors, most plan sponsors fail to recognize this risk because it is seriously attenuated by actuarial and accounting smoothing of financial statements. Instead, due to the way pension contributions are calculated, and earnings reported, plan sponsors focus on the return on asset assumption rather than assets versus liabilities. The authors look at the performance of defined-benefit corporate pension plans in 2000 and 2001, and consider the implications of this performance for future corporate earnings. They then address issues associated with measuring pension liabilities and offer solutions to deal with this measurement problem.

Pension Asset Allocation Through Surplus Management

(1987). Pension Asset Allocation Through Surplus Management. Financial Analysts Journal: Vol. 43, No. 2, pp. 29-40.