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Valuation DB Pensions. Con Keating TUC conference, London, 2013 [email protected] Valuation is a Dark Art Comparison of Current and Possible Methods. An accurate and unbiased approach The method. Start with the primary fair value condition

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valuation db pensions

ValuationDB Pensions

Con Keating

TUC conference, London, 2013

[email protected]

an accurate and unbiased approach the method
An accurate and unbiased approachThe method
  • Start with the primary fair value condition
  • present value of contributions must equal the present value of the promised pensions
  • This defines the internal growth rate (IGR) of a scheme
  • This is the weighted average cost of capital for a sponsor employer or equivalently the weighted rate of return on contributions to pensioners.
  • In order to compare apples with apples:
    • Project Liability Expense Cash-Flows
    • Project Asset Income Cash-Flows
    • Compare these at the Internal Growth Rate integral to the awards.
  • This produces accurately accurate, stable and unbiased results
  • The reported liabilities are accurate and the scheme funding ratio correct
cash flow projections
Cash Flow Projections
  • Asset cash flows – Bonds contractual and Equities constant real income.
  • Contributions are amortised as pensions are paid and members die.
  • The proposed method is precise and accurate.
  • It is a fair value approach.
  • It outperforms all existing and many possible methods
  • It is decision and prediction useful.
  • It varies only with variation in pension and contribution factors.
  • It carries with it incentives for DB scheme provision .
  • And long-term investment.
  • Current figures overstate the deficit
  • If there is a deficit, there are multiple ways of filling it, of which higher contributions is only one.
  • It is right to be concerned that pension finances are sound
  • but it is also right to be sensible.
  • And if time permits...
how long price and information
How long?Price and Information
  • The minimum length of time to distinguish

price signal from noise

  • If we assume normality in return, we can estimate these times:
  • Only with high return, low volatility strategies are market prices informative. Everywhere else, we are working with noise.
  • Market prices are driven by fear and greed - Anomalies abound
  • Volatility is extremely high.
  • Prices drive returns – Beebower, Brinson.
  • Market returns are negatively correlated

with GDP growth out to about five years

  • This violates Arrow Debreu fixed point

efficient resource allocation equilibria.

  • But as we move to long holding periods,

income dominates and volatility declines.

  • Long term returns are positively

correlated with GDP growth

  • In other words, short term market price

moves converge to the long-term

fundamentals and allocative efficiency

  • But not if we use them as indicators for short-term management actions
  • Such as special contributions and management techniques like LDI which are hedging regulatory and accounting nonsenses.
expected returns corporate bonds
Expected ReturnsCorporate Bonds
  • Suppose we have tow zero coupon bonds outstanding

both have the same maturity, but they were issued with different terms and conditions

  • The bond-holder claims in insolvency differ – the issue terms matter