Retirement Benefits, Economics and Accounting: Moral Hazard and Frail Benefit Designs

Jeremy Gold

North American Actuarial Journal, 2005, vol. 9, issue 1, 88-111

Abstract: This paper uses economic principles to analyze alternative recognition schemes for end-of-period retirement plan liabilities; the candidates, using U.S. nomenclature, are the vested benefit obligation (VBO), the accumulated benefit obligation (ABO) and the projected benefit obligation (PBO).In competitive employment markets with rational contracting we are unable to justify projected costing (PBO-based) for typical pay-related defined benefit plans. Projected costing misrepresents the economic obligations incurred by shareholders and invites moral hazard.Employee exposure to moral hazard may be minimized by exit costing (VBO-based) which recognizes only those benefits to which an exiting employee is entitled under the explicit benefit contract. But exit costing may not fully inform shareholders about the obligations that they have incurred under implicit contracts that extend beyond the plan document. Accrued costing (represented in the United States by the ABO) may better measure shareholders’ economic commitments.Small differences between the ABO and the VBO may measure a human capital asset incented by delayed vesting and benefit eligibility. Large differences are a marker for frail benefit design and potential moral hazard.Moral hazard options exercised by employers disappoint employees and may lead to unwelcome ex-post results-oriented repairs imposed by legislators, regulators and courts.

Date: 2005
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DOI: 10.1080/10920277.2005.10596186

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