Setting the discount rate for defined benefit liabilities—what’s the right approach?
Posted on 18-11-2009 by Craig Turnbull | 0 comments
Our US office recently sponsored a seminar on public pension fund valuation. The discussion focused on the 'right' approach to setting the discount rate for defined benefit liabilities - a market-based approach (based on the Treasury curve at the valuation date), or a long-term expected return on the fund's assets. This led to the usual discussions of the pro's and con's of each approach with respect to economic transparency, stability of funding levels and spurious market volatility, the dubious track record of actuaries as subjective predictors of medium-term asset returns, etc.
One of the key themes highlighted in this discussion was that these measures are really answers to different questions: a market valuation for financial reporting purposes need not mean that contribution rates are calculated every day with reference to the yield curve. However, it was interesting to observe that many in the 'traditional' pension actuarial camp were firmly against the use of market-based liability valuation in any area of public pension fund management (incidentally, we were told that the aggregate size of US Federal, State and Municipal government employees' DB pension fund mark-to-market deficits are allegedly measured in the trillions).
There was particular emphasis on the government as a special case that was an ultra long-term entity, and hence should be valued on a going concern basis that capitalized long-term expected asset returns. So does this mean that if the Federal government were to issue Treasuries tomorrow and invest the proceeds in equity funds, the Federal deficit should suddenly be reduced? If not, why should it work when the equities are put inside a government pension fund?
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