The magic money tree

Just out in the Financial Times this morning. Jonathan Ford writes about a trick which allows insurance companies to conjure capital out of fresh air.

Read the article and support high quality investigative journalism, but the salient points are:

  • Instead of investing £100 of pensioners’ money in safe assets like gilts, an insurer invests in higher-yielding assets, which in theory bring a higher level of investment risk
  • Using Matching Adjustment, the firm discounts its pension liabilities at a higher rate, reflecting the additional return it hopes to make (but is not guaranteed to make, if the theory of ‘higher return = higher risk’ is correct.
  • “When discounted at this new elevated rate, our company’s liabilities obediently fall to just £90. So without anyone contributing a penny, or the company retaining any earnings, hey presto, its equity buffer has risen from nothing to the more substantial level of £10”.

Conclusion: “Long-term savings are a serious business. Outcomes should not hinge on the flick of an actuary’s wand”.