Valuation Of Pension Liabilities Research Articles

Public Pension Governance and Opportunistic Accounting Choice: A Politico-Economic Approach

The selection of actuarial assumptions used to value state and local government pension liabilities is an important culprit of the looming state and local pension crisis in the U.S. Due to the impact these selection choices have on the value of pension liabilities and annual required contributions (ARC), pension plans are often said to make these choices opportunistically for purposes of freeing up budget resources and making pension funding look better. Using empirical data on 114 state-administered pension plans, this research shows that the likelihood of such opportunistic pension accounting choices (OPAC) increases when the plan is underfunded, organized as a cost-sharing plan, governed by a politically embedded fiduciary body, and when the sponsoring government is surrounded by a high degree of unionization, and is divided in terms of partisan control. The results also show that the likelihood of OPAC decreases when a pension plan is subjected to an audit by a Certified Public Accountant (CPA), suggesting that professional gatekeepers can play an important role in limiting the adverse effects of OPAC behavior, including insufficient ARC payments and reduced transparency of governmental financial reports.

Diffusion of fair value measurement (IFRS 13): Perception of Auditors

This study investigates the diffusion of fair value measurement (IFRS 13), with a focus on extent of application, and valuation methods used by reporting entities in Nigeria. Data-collection was through a structured questionnaire administered on 400 auditors from diverse backgrounds in terms of audit firm size, international affiliation, and global presence. Analysis of data obtained from 277 respondents, using descriptive statistics and one-way ANOVA, reveals that the overall extent of application of fair value measurement is moderate. However, there is significant difference in application level among reporting entities in the valuation of financial assets, financial liabilities, investment property, and goodwill & intangibles acquired in business combination, but no significant difference in the valuation of pension liabilities, endowment funds, share-based payments, property, plants & equipment, and land & building. It appears the level of investment in an asset/liability determines the application rate of fair value measurement—while high level of investment in an asset/ liability prompts extensive application, low level of investment correspondingly results into negligible usage. Further, the overall application rate of the valuation methods is in the descending order of: market, expert estimation, cost and income approaches respectively. The market and cost approaches are applied more extensively in the valuation of tangible assets; the market approach is preferred in the valuation of financial instruments, while expert estimation is more applicable in the valuation of intangible assets and liabilities. Given that the market approach is the predominant valuation method, the study calls on relevant authorities and concerned stakeholders to emplace institutional apparatus that will facilitate the ready availability of fair value prices for accounting items.

Actuarial Inputs and the Valuation Of Public Pension Liabilities and Contribution Requirements: A Simulation Approach

There are significant concerns about the financial condition of public pensions in U.S. state and local governments. To date, studies of public pensions have given limited attention to the effect of actuarial inputs on the valuation of pension liabilities and contribution requirements. This paper uses a simulated public pension system to examine the sensitivity of actuarial input changes on funding ratios and contribution requirements. We examine instantaneous and lagged effects, marginal and interactive effects, and effects under different funding conditions and demographic profiles. The findings emphasize the difficulty of conducting cross‐sectional analysis of public pension systems and point to several important considerations for future research.

Old-age provision: past, present, future

This is a summary of the main topics and findings from the Swiss Risk and Insurance Forum 2015. That event gathered experts from academia, insurance industry, regulatory bodies, and consulting companies to discuss the past and current developments and necessary next steps for dealing with old-age provision. Topics include the pension funding gap, demographic and societal challenges, the valuation of pension liabilities, economic and regulatory capital models, and the role of financial markets.

Old-Age Provision: Past, Present, Future

This is a summary of the main topics and findings from the Swiss Risk and Insurance Forum 2015. That event gathered experts from academia, insurance industry, regulatory bodies, and consulting companies to discuss the past and current developments and necessary next steps for dealing with old-age provision. Topics include the pension funding gap, demographic and societal challenges, the valuation of pension liabilities, economic and regulatory capital models, and the role of financial markets.

Do Pension Plans Manipulate Pension Liabilities

We use a historical experiment to test whether U.S. corporate defined benefit pension plans strategically use regulatory freedom to lower the reported value of pension liabilities, and hence required cash contributions. For some years, pension plans were required to estimate two liabilities - one with mandated discount rates and mortality assumptions, and another where these could be chosen freely. Using a sample of 11,963 plans, we find that the regulated liability exceeds the unregulated measure by 10 percent and the difference further increases for underfunded pension plans. Moreover, underfunded plans tend to assume lower life expectancy and substantially higher discount rates. The effect persists both in the cross-section of plans and over time and it serves to reduce cash contributions. Finally, we show that credit risk is unlikely to explain the finding. Instead, it seems that plans use regulatory leeway as a simple cash management tool.

Towards a European Pension Directive: On Holism, Actuarial Interest Rates and Pensions

In this article we will discuss what the work of the EC and EIOPA means and how we should move towards a more objective valuation of pension liabilities in the EU. There are many different kinds of pension liabilities in the European Member States, and there are at least just as many different ways of financing them. This means that the pension liabilities must first be analysed in order to take the right approach to valuation. We will describe this and draw some conclusions.

Do Pension Plans Manipulate Pension Liabilities?

We use a historical experiment to test whether U.S. corporate defined benefit pension plans strategically use regulatory freedom to lower the reported value of pension liabilities, and hence required cash contributions. For some years, pension plans were required to estimate two liabilities - one with mandated discount rates and mortality assumptions, and another where these could be chosen freely. Using a sample of 11,963 plans, we find that the regulated liability exceeds the unregulated measure by 10 percent and the difference further increases for underfunded pension plans. Moreover, underfunded plans tend to assume lower life expectancy and substantially higher discount rates. The effect persists both in the cross-section of plans and over time and it serves to reduce cash contributions. Finally, we show that credit risk is unlikely to explain the finding. Instead, it seems that plans use regulatory leeway as a simple cash management tool.

Corporate Pension Plans as Takeover Deterrents

AbstractWe use UK data to show that firms that sponsor a defined-benefit pension plan are less likely to be targeted in an acquisition and, conditional on an attempted takeover, they are less likely to be acquired. Our explanation is that the uncertainty in the value of pension liabilities is a source of risk for acquirers of the firm's shares, which works as a takeover deterrent. In support of this explanation we find that these same firms are more likely to use cash when acquiring other firms, and that the announcement of a cash acquisition is associated with positive announcement effects.

Factors in Managing Actuarial Assumptions for Pension Fair Value: Implications for IAS 19

Corporate managers make several discretionary assumptions (i.e., the rate of salary growth and assumed return rate of pension plan assets) in calculating the fair value of pension assets and value of pension liabilities. In this study, we examine the factors that can induce managers to increase (decrease) fair value of pension assets (liabilities) through pension assumptions. We use the Taiwan setting as a natural experiment because Taiwan is planning to adopt IFRS from 2013 on. The estimation of pension asset (liability) value is similar between Taiwan accounting standards (i.e., TFAS 18) and international accounting standards (IAS 19); however, fair value is only disclosed in the financial statements under TFAS 18, but is required to be recognized in the balance sheet under IAS 19. The findings under TFAS 18 can provide important implications for future adoption of IAS 19. Using two key inputs for pension pricing model, this study finds that companies are inclined to increase (decrease) the value of pension assets (liabilities) by rising (lowering) the assumed expected rate of asset returns (expected salary growth). The manipulation is more pronounced for firms with high distress risk and complex ownership structure. Prior studies find that once firms are required to recognize the fair value (i.e., adopting IAS 19) as opposed to disclose the information (i.e., TFAS 18), firms have higher incentives to manipulate the model inputs. This suggests that the regulator needs to specify the authoritative enforcement rules regarding fair value estimation, and provides more insights on firms with high distress risk and complex ownership structure.

Second International comparative study of mortality tables for pension fund retirees

AbstractThis paper contains an update to the first international comparative study of mortality tables carried out in 2006. It examines the mortality assumptions used in the valuation of pension liabilities in a number of different countries. The results are considered in relation to the underlying population mortality rates, in order to isolate the strength of the mortality assumptions being applied. It is found that there is evidence of a lack of consistency between countries, and that this has not changed since the previous study.

The Annuity Duration Puzzle

We test whether life-contingent annuity prices promptly and fully adjust to changes in interest rates; a standard assumption made implicitly or explicitly in a growing annuity literature. Using a unique database consisting of over 3 million U.S. annuity quotes, we find that prices do not move as one might expect. Rather, prices adjust gradually and over a period of several weeks and often months, in response to certain -- and not necessarily riskless -- interest rate changes. In particular, we find that changes to the 30-year U.S. mortgage rate provide a better fit and indication of where annuity payouts are headed, compared to the 10-year swap rate, for example. In addition, we find that the sensitivity to interest rate changes (a.k.a. annuity duration) is asymmetric. Annuity prices react more rapidly and with greater sensitivity to an increase in the relevant interest rate compared to a decrease. Overall our findings are inconsistent with a financial economic view of a life annuity as a risk-free bond-like instrument, plus mortality credits. We believe that we are the first to examine the dynamic microstructure of annuity prices and that our results have implications for a wide swath of existing literature. This includes portfolio choice at retirement, the optimal timing of annuitization, the money's worth ratio, the inference of mortality expectations from insurance prices as well as the valuation of pension liabilities.

Pension costs and liabilities for UK-regulated utilities

AbstractThis paper argues that a substantial portion of the risks associated with the defined benefit (DB) pension schemes operated by regulated utilities in the UK will, in practice, fall on customers via the tariffs that they pay for regulated goods and services. It examines the assumptions made by regulated companies in their FRS 17 valuations. These assumptions generate parameters that systematically understate both the present value of pension liabilities and current service costs. These are re-estimated using the risk-free real rate of discount and compatible assumptions. On this basis, the total pension deficit for the sample increased from £12.7 billion to £56.3 billion in 2009, equivalent to about 110% of regulated revenues. Further, the cost of current service for 2008–09 was 20% higher than total contributions in the year, despite large top-up contributions. If contributions were increased to cover current service costs and to eliminate pension deficits over a period of 10 years, the additional contributions would amount to 235% of actual contributions or 13% of regulated revenues implying a significant increase in regulated charges. Companies in the communications and transport sectors face the largest adjustments in addressing the problems of underfunded pension schemes.

Estimation of Implicit Pension Debt in Russia

In the article the results of modeling the dynamics of insurance component of retirement pension in Russia are considered. The author outlines the current pension scheme and stresses the significance of implicit pension debt as an important tool for pension liabilities evaluation. Estimation results include computing the current value of pension liabilities in Russia, costs of pension reforms and dynamics of pension deficit for the future.

Do Managers Manipulate the Reported Values of the Pension Liabilities?*

In this paper I examine the valuation of pension liabilities, based on a structural equations model which permits investigating the subject of earnings management effected by adjusting the reported values of pension liabilities by the companies sponsoring defined benefit pension plans.The results of the analysis are consistent with managers manipulating the Projected Benefit Obligation when doing so helps reporting a smooth earnings trend, when the pension fund is substantially over-, or underfunded, when firms report negative income, when firms are facing financing constrains and when firms are getting close to violating debt covenants. Finally, the evidence is consistent with managers of regulated companies, such as financials and utilities, also manipulating the reported values of pension liabilities when the pension fund is substantially over-, or underfunded, when the company is getting close to violating debt covenants or when the company reports losses.

Valuation of pension liabilities in incomplete markets

AbstractThis paper discusses the valuation of wage-indexed pension liabilities. Valuation of these contingent claims by replication is typically not possible as the wage index cannot be hedged perfectly with financial market instruments. This paper discusses several methods to find a value in such incomplete markets and advocates utility-based valuation. This approach implies a simple adjustment on the discount factor.

Valuation of Pension Liabilities in Incomplete Markets

This paper discusses the valuation of financial instruments whose payoff is linked to an index. Examples are TIPS, wage-indexed pension fund liabilities, and GDP bonds. Valuation of these primary assets by replication is typically not possible as the index cannot be hedged perfectly with (nominal) market instruments. This paper discusses several methods to find a value in such incomplete markets and advocates utility-based valuation. This approach implies a simple adjustment on the discount factor.

Why Not Trade Pension Claims?

Trading pension claims would serve many purposes. Beneficiaries would be able to diversify the idiosyncratic credit risk of their plan sponsors. And systematic risk could be reallocated to comply with individual risk–return preferences. The result would be an alignment of companies’ and pension fund managers’ incentives to keep fund plans fully funded—in line with beneficiary interests—which would lower agency costs and costs of government bailouts of defined-benefit plans and would improve the general welfare. As an accurate valuation of pension liabilities, trading would provide a measurable yardstick for plan managers.

Let Us Trade Pension Claims

Trading pension claims would kill many birds with one stone: an accurate valuation of pension liabilities would provide a measurable yardstick for plan managers; beneficiaries would be able to diversify the idiosyncratic risk of their plan sponsors; systematic risk could be reallocated to comply with individual risk/return preferences. The consequence would be an alignment of incentives to fully fund plans, lower agency and governmental bail-out costs, and an increase in general welfare.

Pension Asset Allocation Through Surplus Management

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