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  #1  
Old 09-13-2010, 11:37 PM
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Default Discount rates for pension liabilities

Why aren't the discount rates, according to the funding and accounting side, for the valuation of pension liabilities the same?

Also, for the accounting side, why are there many different pension yield curve indexes? Like the Mercer Index or the Citigroup Index. Is there a situation where a client would like to use, say the Mercer Index as opposed to the Citigroup index?

Why not just use the swap curve for both funding and accounting?

TIA.
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Old 09-14-2010, 08:46 AM
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Why not just use the swap curve for both funding and accounting?
Good luck getting a good answer to this from an actuary.

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1. Pandering - we marketed ourselves as finding clever ways to give the public pension sponsors something for nothing
2. Ignored consequences - we found clever ways to allow politicians to ignore the true costs of benefit increases, like negative amortization of losses
3. Low standards of measurement - GASB had the most simple-minded of standards, and is now only going half-way to raise the standard.
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Old 09-14-2010, 09:31 AM
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Good luck getting a good answer to this from an actuary.

Politics.

Is that good enough for you WWS?
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Old 09-14-2010, 10:10 AM
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Politics.

Is that good enough for you WWS?
That, and history. A lot of actuaries made a lot of money under the rules now (and previously) in place. Hard to change quickly.

Frankly, I think that the science of discount rates is still evolving. Maybe some day we will learn that the swap curve isn't the right answer either.
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Old 09-14-2010, 11:03 AM
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Politics.

Is that good enough for you WWS?
You made me waste half a bag of popcorn.
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We, the actuarial profession, did several things badly.

1. Pandering - we marketed ourselves as finding clever ways to give the public pension sponsors something for nothing
2. Ignored consequences - we found clever ways to allow politicians to ignore the true costs of benefit increases, like negative amortization of losses
3. Low standards of measurement - GASB had the most simple-minded of standards, and is now only going half-way to raise the standard.
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Old 09-14-2010, 11:23 AM
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You might want to ask that question here:
http://www.actuarialoutpost.com/actu...d.php?t=191744
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  #7  
Old 09-14-2010, 11:38 AM
Jeremy Gold Jeremy Gold is offline
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As explained in the Pension Actuary's Guide to Financial Economics, there are reasons to use different discount rates for funding and financial reporting (but the current differences do not follow the reasons in the Guide).

If society chooses to require funding for corporate DB plans because society expects promises made to become promises kept, then the discount rate for funding should be default free. Some of the reasons are discussed here on page 7 (one-pager):

http://www.soa.org/library/newslette...er/psn0309.pdf

For financial reporting, we want to establish a market-based value for promises that is consistent with other such promises on a balance sheet. At issue, corporate debt is priced at a discount rate that admits the possibility of default. (Unfortunately, the accountants have not yet agreed to re-mark outstanding bonds to current market). Thus the discount rate for financial reporting is always equal or greater than the default-free funding rate.

Collateralized promises (mortgages of real assets, debt with a dedicated sinking fund, some insurance separate accounts) are more valuable than the general credit of a corporate promiser. This implies that, for a funded pension plan, we should use a lower discount rate for financial reporting than for an unfunded plan (e.g., a SERP) for the same corporation.

If funding rules were strong enough, collateral would be sufficient to drive down the discount rate for funded plans to nearly the default free rate used for funding.

In that case we could use the same rate for funding and financial reporting.

In my judgment, the arguments for using swap rates are about as good as the arguments for using default free sovereign debt (e.g., Treasuries in the US). Neither curve is perfect and, since they are usually pretty close to each other, either is probably satisfactory and either would be an improvement over using the PPA double-A curve.

I attribute the PPA use of the double-A curve to a misstatement made by a Deputy Treasury Secretary, circa 2003, to the effect that pension promises are risky and thus we should use high grade corporates for funding rules. He was confusing financial reporting and funding and, IMO, should have known better. OTOH, he is a lawyer and not an economist, actuary, or bondtrader by training.

About two years after his offhand comment in congressional testimony (and after the Deputy Sec'y) had gone into private investment management, an Assistant Secretary, an economist BTW, implement a very complex corporate curve that, I am told by bond experts, cannot be hedged without extraordinary (e.g., 500 bps) tracking error. And this is before 24-month averaging and 3-bracket segmenting. Part of the reason it can't be hedged is that each month is a 20-day average of yields in the month. There is also an anti-volatility adjustment built in to the raw rates deliberately to underweight longer duration securities -- why anyone would put that into the benchmark rather than into the funding rules -- who knows. Caveat: I was told all in this paragraph by bond experts I trust, but I have not done independent research.
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Old 09-16-2010, 10:59 AM
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Good luck getting a good answer to this from an actuary.

The rules seem like intellectual masturbation -- there is a point where the costs exceed the benefits of a seemingly "accurate" measure of the pension liability, and I feel as though the rules have crept over into the cost>benefit domain.

I am sure the actuaries are hesistant to change the rules. Complexity -> more job skill -> higher salaries.
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Old 09-16-2010, 02:14 PM
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Jeremy's post is worth re-reading. It's one of the more clear and concise explanations I've read.

I think the answer on the funding side is simply that sponsors (in general; there are certainly exceptions) want to defer putting as much money into the plan as long as possible. So they lobby Congress to make rules to allow this. At the same time, Congress wants to look like they are protecting pensions, so rather than write funding rules that require funding, say, 70% of the risk-free liability, they obfuscate and pick a smaller (and somewhat arbitrary) liability to fund to 100% of.

Anyone who claims that AA corporates are the "right" measure of funding liability is either terribly confused or has an agenda.

On the accounting side, there is a decent argument for corporations to use their own corporate bond rate to determine liabilities. But that leads to some perverse incentives - e.g. if they can get themselves downgraded to junk status, their pension obligations magically shrink.
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Old 09-16-2010, 03:41 PM
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Originally Posted by Mr. BoH View Post
Jeremy's post is worth re-reading. It's one of the more clear and concise explanations I've read.

I think the answer on the funding side is simply that sponsors (in general; there are certainly exceptions) want to defer putting as much money into the plan as long as possible. So they lobby Congress to make rules to allow this. At the same time, Congress wants to look like they are protecting pensions, so rather than write funding rules that require funding, say, 70% of the risk-free liability, they obfuscate and pick a smaller (and somewhat arbitrary) liability to fund to 100% of.

Anyone who claims that AA corporates are the "right" measure of funding liability is either terribly confused or has an agenda.

On the accounting side, there is a decent argument for corporations to use their own corporate bond rate to determine liabilities. But that leads to some perverse incentives - e.g. if they can get themselves downgraded to junk status, their pension obligations magically shrink.
I might add that thhe IRS also has some irons in the fire. They want to make sure nobody claims too big a deduction on the corporate income tax for contributions.
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And def agree w/ JMO.
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This. And everything else JMO wrote.
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Depends upon the employer and the situation.
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I feel like ERM is 90% buzzwords, and that the underlying agenda is to make sure at least one of your Corporate Officers is not dumb.
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