Market-Consistent Valuation and Funding of Cash Balance Pensions

• Published in: North American actuarial journal Vol. 18; no. 2; pp. 294 - 314
• Main Authors: Hardy, M. R., Saunders, D., Zhu, X.
• Format: Journal Article
• Language: English
• Published: Schaumburg Routledge 01-01-2014; Taylor & Francis Ltd
• Subjects: Accounting; Cash balance pension plans; Credit ratings; Employers; Financial analysis; Interest rates; Liability; Market value; Pension plans; Studies; Tax regulations; Valuation; Wages & salaries; United States > US
• ISSN: 1092-0277; 2325-0453
• DOI: 10.1080/10920277.2014.906154

Cash balance pension benefits are accumulated at guaranteed crediting rates, usually based on yields on government securities. Viewed as a financial liability, the benefit is a form of interest rate derivative, which can be valued using financial models and theory. In this article, we derive the market value for a range of commonly used crediting rates, assuming the accrued benefit liability comprises the past contributions, allowing for full interest credits up to a known future retirement date. We use the Hull-White interest rate model to determine crediting rates and to determine the market value. We explore the risks associated with different crediting rate choices by evaluating the liability using market data from 1998 to 2013. We propose two other approaches to the accrued benefit. The first approach assumes the accrued benefit comprises past contributions with interest up to the valuation date, but no future interest credits. Future credits on past contributions are assumed funded through future contributions. The second method projects all contributions and interest to retirement and assumes equal units of accrual of this projected benefit in each year of service. We compare the three approaches through numerical examples.