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TThe Discount Rate Debate and Its Implications for Defined Benefit Pensions

Woon Wong ()

No E2018/12, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: While the Universities Superannuation Scheme recently reported the biggest deficit of any British pension fund, the union's actuary finds no funding crisis for the scheme. The huge contrast can be explained by the current debate on whether low gilt yields imply low future returns on other asset classes. This article argues that falling interest rates since 1980s are essentially the result of successful monetary policies to control inflation, thereby the economy benefited and firms made good profits, giving rise to healthy funding level for the scheme. Since index-linked gilt yields are found to explain up to 99% variation of its past liabilities, the scheme is likely to be in surplus if a correct discount rate is used in the valuation. The implications are that many past closures of defined benefit schemes were unwarranted, expensive disputes could have been avoided and firms' spending on such schemes are unnecessarily high.

Keywords: pension; defined benefit; discount rate; risk-free rate; equity risk premium (search for similar items in EconPapers)
JEL-codes: G1 G22 G23 G3 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-age
Date: 2018-12
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