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  #141  
Old 08-17-2016, 06:10 PM
Helen Sass Helen Sass is offline
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Riskier for whom? The sponsor, or the plan participants?
If we are being serious here, the way to make the liabilities more at risk would be to condition their payment on the funds being available to pay them, rather than require the plan sponsor to come up with the money for them.

If we are not being serious, maybe instead of making the liabilities riskier we find a way to make them more risqué. IYKWIM.
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  #142  
Old 08-18-2016, 01:54 PM
Jeremy Gold Jeremy Gold is offline
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More than that, the discount rate for riskier assets should be higher, but the discount rate for riskier liabilities should be lower. (This issue is more significant in areas other than pensions, but I have seen it misunderstood.)
Although there are some cases where liability discount rates should be lower, this is not universal. If the liability uncertainty is correlated with market assets that earn a risk premium, so should the liability discount rate reflect a risk premium. Example, a liability denominated in units of the S&P 500 should include a discount for the S&P 500 risk premium. If liabilities were correlated with a negative beta security (e.g., gold stocks in some time periods), then the negative risk premium on gold stocks would attach to the liability.

The most interesting case, and the one I think you are referring to, is where there is white noise (zero beta). In effect, the liability has attached to it a risk that cannot be hedged. In that case the value of the liability increases because you would have to pay someone to accept your unhedgeable risk. If that same white noise were attached to an asset, the value of the asset decreases, again because any buyer of the asset would be stuck with the unhedgeable risk.
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  #143  
Old 08-18-2016, 02:07 PM
Dr T Non-Fan Dr T Non-Fan is online now
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Dr. Gold, aren't you the one who strongly recommends that liabilities be discounted with a risk free rate?
In effect (correct me if I'm incorrect), stating "What the assets are is not a concern of the liability side. It is the asset side's job to meet the discount rate used by the liability side."
Because, if the assets return doesn't match the discount rate, doesn't that mean, ceteris paribus that a higher contribution is required?

I only know from basic actuarial exam texts, so forgive my limitation.
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  #144  
Old 08-18-2016, 02:09 PM
Jeremy Gold Jeremy Gold is offline
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The point Jeremy is making (I think) is that there are no riskier or less risky liabilities - they are all virtually guaranteed so we should always use a risk-free rate to discount them regardless of how the assets are invested.
I think I see why some of what I say sounds like that but I think my view is a little narrower: those liabilities that are default-free and bond like should be discounted using default-free bond rates. Even in public pensions, however, we know that some liabilities may have market sensitivities. Automatic COLAs require adjustment for implied inflation forwards and some options may be sensitive to changes in interest rates. I think I am saying that the default-free liability is a special case (but a very common one).

Furthermore, if we are measuring liability value as a step in a funding process, we should not incorporate benefit defaults. But if we are evaluating the value of promised benefits, to the employees (e.g., in the context of total compensation), then we should discount the liabilities for default.

In the generally rare case where accrued benefits are linked to other marketed securities, pertinent risk premia can be included in the discount rates.
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  #145  
Old 08-18-2016, 02:43 PM
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I think what Carol is referring to is the fact that the payouts representing the liabilities are estimated, and are subject to variation. Investors are risk averse; hence (all else equal) they would charge more to assume a liability where the payouts can vary, than one where the payout is known exactly.

ninja'd - sorry.

One factor not taken into account by financial economists (or in accounting) is the economic concept represented by the 'goodwill' accounting concept. Plan sponsors sponsor pension plans not out of a charitable motive, but in order to attract and retain talented employees. To the extent a pension plan can do this, it adds value to the firm.
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  #146  
Old 08-18-2016, 02:56 PM
nonlnear nonlnear is offline
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...

One factor not taken into account by financial economists (or in accounting) is the economic concept represented by the 'goodwill' accounting concept. Plan sponsors sponsor pension plans not out of a charitable motive, but in order to attract and retain talented employees. To the extent a pension plan can do this, it adds value to the firm.
IMO these days, benefits like pensions don't function to attract talent so much as attract capable employees who are content to remain underpaid. If anything, a pension heavy package repels talent.

No talented person under 40 gives a crap about a pension, because caring about a pension implicitly limits your career options. And exercising that optionality is how talented people grow their pay faster than their peers. Pensions, vesting, and the like are typically structured to make for an extra layer of clawback with which to punish people who don't want to stay for 3% raises. It's all about that base, 'bout that base, no pension.

But I guess form a management perspective, employees who are content to remain underpaid are "talented" in the sense that that characteristic creates value for the company.

Last edited by nonlnear; 08-18-2016 at 03:01 PM..
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  #147  
Old 08-18-2016, 05:51 PM
Jeremy Gold Jeremy Gold is offline
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Originally Posted by Dan Moore View Post
One factor not taken into account by financial economists (or in accounting) is the economic concept represented by the 'goodwill' accounting concept. Plan sponsors sponsor pension plans not out of a charitable motive, but in order to attract and retain talented employees. To the extent a pension plan can do this, it adds value to the firm.
If and when you get to see the repressed paper you will see that we acknowledge this in general terms:
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Although defined benefit plans may destroy value by imposing unhedgeable risks on their sponsors and employees , plans can create value through longevity pooling, workforce management, and tax preferences (to the extent that society finds career savings and lifetime income worthy of such preferences).

Benefit design implications – benefit designs that are hedgeable are generally more efficient than those that are not . To the extent possible, benefits should be designed to be hedgeable, reducing the costly wedge between sponsor and employee valuations. Off-market specifications are always inefficient because they provide less value to the recipient than cost to the payer.

There is a strong exception to the above. Benefit design features that facilitate workforce management (attraction, retention, and disposition of employees) may add value to the sponsor and its employees combined. This case can be made for vesting schedules, early retirement windows, etc.
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  #148  
Old 08-18-2016, 06:02 PM
Jeremy Gold Jeremy Gold is offline
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Originally Posted by Dr T Non-Fan View Post
Dr. Gold, aren't you the one who strongly recommends that liabilities be discounted with a risk free rate?
In effect (correct me if I'm incorrect), stating "What the assets are is not a concern of the liability side. It is the asset side's job to meet the discount rate used by the liability side."
Because, if the assets return doesn't match the discount rate, doesn't that mean, ceteris paribus that a higher contribution is required?

I only know from basic actuarial exam texts, so forgive my limitation.
Discounting at the risk-free (default-free) is the first-order solution that covers most of the value we're trying to measure. Additional refinements in this thread are second-order adjustments.

Because the EROA is ridiculously far from the risk-free rate, the significant mismeasurement is pretty well captured by revaluing the accrued liabilities at the risk-free rate. Additional tweaks (+/-) might become important if the standard actuarial model were amended to throw out the EROA and use risk-free rates. Then we could zoom in on the second order issues.

I don't recognize this: "What the assets are is not a concern of the liability side. It is the asset side's job to meet the discount rate used by the liability side."

It is possible that I said it but also possible that you have paraphrased something. Can you source the quote?
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  #149  
Old 08-18-2016, 06:29 PM
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The liabilities have a value even if there are no assets -- and, going even farther, if there are no plans to ever have any assets. A purely pay-as-you-go pension plan (like Social Security effectively was for many years) still has liabilities, and those liabilities have a present value that can be determined without reference to any assets in the plan.

Bruce
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  #150  
Old 08-19-2016, 09:37 AM
exactuary exactuary is offline
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Originally Posted by bdschobel View Post
The liabilities have a value even if there are no assets -- and, going even farther, if there are no plans to ever have any assets. A purely pay-as-you-go pension plan (like Social Security effectively was for many years) still has liabilities, and those liabilities have a present value that can be determined without reference to any assets in the plan.

Bruce
What you say applies to Social Security as long as we believe that Congress will not alter accrued benefits and that the SS promise has the full faith and credit of the US behind it.

But assets in other plans can affect the value of the liabilities they stand behind. The assets represent collateral and strengthen the liabilities.

But the expected return is not a key factor in measuring PV.

Imagine a weak sponsor has a plan with liabilities that would be worth $100 if risk free. With no funding, the promise might be worth only $60.

Now add $50 worth of bonds. The PV might increase to $80. Now add $30 in equities on top of the bonds. The expected return increases over what it was with only bonds in the plan. But the value of the liabilities increases again, perhaps to $90, due to increased collateral. The liabilitiy increase from $80 to $90 implies a lower discount rate for the liabilities even though the expected asset return has gone up.
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