Valuing Defined-Benefit Plans

Abstract

We examine issues surrounding the valuation of defined-benefit pension plans including benefit formulas, integration with Social Security, postretirement benefit increases, and default risk. We obtain a reasonible valuation with three key estimates—the level of retirrement benefits, the growth rate of postretirement benefits, and the discount rate. We consider the PBGC guarantee afforded many DB pensions. Usually, benefits are essentially default-risk-free, and the discount rate can be based on Treasury yields. We also offer methodological advances over current approaches. DB valuation is crucially relevant to asset allocation decisions and has litigation implications.

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