http://batmanytb.com/Actuary%20(Comics)
As I commented the other day, life insurers have for a long time used arbitrary methods of discounting insurance obligations. The idea permeates actuarial culture and most actuaries, including even the younger actuaries who qualified under the new actuarial syllabus designed to drag actuarial valuation into the 1950s, show surprise when you suggest that this is completely wrong.
To show why it is completely wrong, suppose I have an asset with market value X that completely hedges my insurance obligations. A complete hedge means that in any possible future state of the world, the payoff of the asset completely matches the repayment of the obligation, hence profit zero. But a position that pays exactly nothing in whatever circumstance has a value of zero, right? So X (the value of the asset) less the value of the obligation Y must be zero. Simple maths suggests that if X – Y = 0 then X = Y, so the present value of the obligation is also X.
The failure to understand this underlies all the current problems of life insurance, from the valuation of equity release guarantees to the current mess in the USS pension scheme.