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The Actuary The magazine of the Institute & Faculty of Actuaries

ACA fends off criticism of asset valuation model

In a letter to the Financial Times today, Mr Southall (pictured) responded to an early letter sent to the paper by economics professor Dennis Leech who claimed actuaries used inadequate methods to value assets.

Professor Leech said the process largely ignored future income streams from investments.

"Instead, the actuaries rely on a fundamentalist theory, that markets are efficient, and only current market values of assets are needed because they convey all the information needed about future earnings," he said.

"But these market prices fluctuate wildly for all sorts of reasons unconnected with future earnings - notably short-term speculation, fluctuations in general market sentiment, and so on."

But Mr Southall responded that many schemes already used valuation methods which paid full regard to the shape of interest rate yield curves and inflation curves.

He explained that this meant projected cash flows were valued in line with the best market-led information across the full time period over which benefits were expected to be delivered.

"This includes, where appropriate, making some prudent allowance for the higher returns which asset classes, such as equities, are expected to deliver," he said.

Southall conceded that this could not eliminate funding level volatility, which would require better matching of assets and liabilities and sophisticated hedging to remove volatility from unrewarded interest and inflation rate risk.

He added that pension accounting standards, the minimum funding requirement, and now the scheme-specific funding requirements, had all driven actuaries to use a marked-to-market value of liabilities.

"There can be no winding back the clock, but it may well be that [using a discounted equity income model] would now be leading to more stable outcomes; albeit that we would then be criticised for yet more smoke and mirrors, he said.

Mr Southall assured Professor Leech that the majority of actuaries did indeed subscribe to his "sensible" approach and sought to "base pension scheme valuations on a comparison of future streams of income and liabilities [valued] on a consistent basis".

Source: Professional Pensions