Kevin just spotted an excellent piece by our friend David Miles (ex MPC at the Bank) on the valuation of pension liabilities.
You can look at the piece for yourself, but it is a neat and clear explanation of why it is wrong to discount pension liabilities at the rate of return on risky assets.
If you do so, you are misleading people who believe pensions are firm commitments “by creating a single measure of the state of the scheme that depends on risky assets not underperforming an average outcome.”
This does not mean (as some detractors argue) that a pension scheme cannot hold risky assets. But if it does, either (i) the scheme sponsor is able make good any deficit that might arise (because of the risk) OR (ii) those who would face the consequences of underperformance of the risky assets understand the risk they are taking and willingly accept it.
Slide 16 is interesting. David describes a ‘sure way of making money’ by borrowing £1m at the risk free rate, investing in risky assets with a higher yield, then discounting the loan at the risky rate, thus valuing it at only £675k, leaving a clear £325k which can be paid as a dividend to yourself. Any resemblance to the article I wrote for the Cobden Centre in 2017 ( ‘Taken to the Cleaners,’) is not in fact a coincidence, for reasons which will be obvious.