$1000 prize!!

[Dan Moore]

This post is to announce that I'll be performing an experiment in this thread to see if anyone can present an argument supporting the position that pension liabilities should be discounted at risk-free rates, which is either based on empirical evidence or valid deductive logic. To the first person to do so (after the experiment goes into effect in a few days) I will give $1000.

As with my earlier $200 prize thread, I don't believe such an argument exists. Therefore, I don't expect to actually pay out the $1000. However (of course), I don't know everything, so I could be wrong.

I will be providing background information and rules to be eligible for the $1000 prize.

[Ve Vant Ze Money]

Pension liabilities should be discounted at risk-free rates because I have seen people do so. Because I've seen it happen, this is based on empirical evidence.

I gonna git rich!

[Duffer]

Risk-free => most expensive possible purchase price for the payment stream.

Nearly risk-free => market price of payment stream by reliable vendor

Risky => hopeful promise made to get the money, expecting that someone else will be there to reinsure the risk

Risk-free => paying a call girl $1,000

oops, got distracted there. what was your point?

[ElDucky]

Can I just post a link to the pension exam syllabus and reduce the issue to a previously solved problem? I mean, they do present counter arguments, but the readings seem a bit one sided.

[ElDucky]

There is one argument I haven't seen made, which I thought might be relevant.

FE argues that for tax purposes, the pension plan should be mostly or totally invested in bonds, while the shareholder can take equity risk in their own portfolio. This is more tax efficient, because the pension plan doesn't pay tax on the highly taxable bonds, while the shareholder pays tax on the less taxable equities.

Their argument is that we have to look at a shareholder perspective rather than just the pension plan perspective. Ok, but why not look at a societal perspective. If something is more tax efficient, that just means the government is getting less money. The overall effect is zero sum and thus neutral.

So from a pension only perspective, equities are good for pension, but ignores shareholders. So we moved to a shareholder perspective, where bonds are good, but ignores society. So, we move to a societal perspective, where improving shareholder fortunes comes at the expense of needing to raise taxes elsewhere, so it is net neutral.

This is somewhat similar to how DC plans have offloaded risks from sponsors, but have inreased risk on society. I haven't thought this one through entirely, so there are likely some flaws, but I believe the concept is sound.

[Mark Cavazos]

Originally Posted by Duffer

Risk-free => paying a call girl $1,000

oops, got distracted there. what was your point?

I am not so sure that a $1,000 call girl is risk-free.

[SirVLCIV]

I need to think through things more carefully, but everything, in the end, boils down to perspective.

Company/Shareholders vs. plan participants vs. IRS vs. PBGC, etc. I'll have to think about what the 'proper' discounting rates would be, but it's NOT going to be the same for each stakeholder.

[JMO]

So long as the judge of this contest has already decided that no proof is acceptable, there's no point in entering. Just sayin'

[Dan Moore]

Originally Posted by ElDucky

Can I just post a link to the pension exam syllabus and reduce the issue to a previously solved problem? I mean, they do present counter arguments, but the readings seem a bit one sided.

You needn't worry about counter arguments - this thread is only for posting arguments in favor of the position that the fair value of pension liabilities is correctly calculated by using risk-free rates. (Slight wording change from what I said before, but I haven't officially finalized the rules for this experiment, which I think will start on Wednesday, March 9.)

As far as using a link, that would depend on what's at the link. If the document there is long, you should indicate what section(s) you're referring to - page and paragraph numbers.

I don't think I've read the document you're talking about, but I'd like to point out a potential issue. There's an apparent error in the standard argument: pension claims by participants are assumed to be well modeled by the Arrow-Debreu model (the asset pricing model in financial economics). However, this is clearly false because the Arrow-Debreu model is based on a Walrasian market, while pension claims are neither traded nor tradeable. If the document at your link resolves this issue using valid deductive logic or empirical evidence, you should be good to go. If it doesn't, then you have to resolve it. Good luck!

[Dan Moore]

Originally Posted by ElDucky

There is one argument I haven't seen made, which I thought might be relevant.

FE argues that for tax purposes, the pension plan should be mostly or totally invested in bonds, while the shareholder can take equity risk in their own portfolio. This is more tax efficient, because the pension plan doesn't pay tax on the highly taxable bonds, while the shareholder pays tax on the less taxable equities.

Their argument is that we have to look at a shareholder perspective rather than just the pension plan perspective. Ok, but why not look at a societal perspective. If something is more tax efficient, that just means the government is getting less money. The overall effect is zero sum and thus neutral.

So from a pension only perspective, equities are good for pension, but ignores shareholders. So we moved to a shareholder perspective, where bonds are good, but ignores society. So, we move to a societal perspective, where improving shareholder fortunes comes at the expense of needing to raise taxes elsewhere, so it is net neutral.

This is somewhat similar to how DC plans have offloaded risks from sponsors, but have inreased risk on society. I haven't thought this one through entirely, so there are likely some flaws, but I believe the concept is sound.

This is a separate (but related) topic which I've dealt with here. Basically, this argument ignores the detriment to shareholder value that results from dumping a ton of stocks.