How Is the Risk of Mortality Factored into a Present Value?
Some evaluators mistakenly believe that mortality is factored into a present value by calculating the fixed number of years that the pension will be paid based on the participant’s life expectancy. Use of a fixed, immutable life expectancy has several serious flaws. For one thing, it assumes that a plan participant will live to his retirement age and then survive to his life expectancy. To accurately factor in mortality risks, however, every pension payment must be reduced to reflect the probability that the participant will actually live to receive that payment. For example, if a male plan participant is currently 50 years old, the probability factor that he will live to collect his first payment at age 65 is approximately 88.96 percent. Thus, the present value for that first payment should be reduced by 104 percent to reflect mortality concerns. When the mortality reduction for each payment is coupled with an interest discounting factor and all payments are summed, the result is the
