Includes “How much does it cost to fund a traditional final salary pension? … There are really three ways of costing this. The first, practiced by US public sector pension funds, is to discount the liabilities by the assumed rate of return on the fund. This is subject to all manner of criticisms; first, it encourages overoptimism, second, expected returns are unlikely to match assumptions, third, no other liability (tax, debts to suppliers) is accounted for in this way and fourth, the liability will still be there even if the assumed return is not achieved. Financial economists and regulators have, on the basis of this last point, argued that a pension is a bond-like liability. So the second cost approach is to discount the liability by corporate bond yields (those rated AA). And the third approach is even harsher; what it would cost the employer to match the cashflows exactly without risk? The answer is to buy inflation-linked government bonds…”
Read the full article on: The Economist