The NYT describes the woes of a small California pension due differences between actuaries and economists.
The two competing ways of valuing a pension fund are often called the actuarial approach (which is geared toward helping employers plan stable annual budgets, as opposed to measuring assets and liabilities), and the market approach, which reflects more hard-nosed math.The market value of a pension reflects the full cost today of providing a steady, guaranteed income for life -- and it's large. Alarmingly large, in fact. This is one reason most states and cities don't let the market numbers see the light of day. ...
The market-based numbers are "close to the truth of the liability," Professor Sharpe said. But most elected officials want the smaller numbers, and actuaries provide what their clients want. "Somebody just should have stopped this whole charade," he said.
In short: the actuaries justify low numbers that please their clients (the governments who administer the pensions) while the economists warn that the pensions are vastly underfunded.
Mega McArdle gives a good description of discount rates.
A discount rate is a way of accounting for the fact that dollars in the future are not quite the same as dollars you have right now.You know this, don't you? Imagine I offered to give you a dollar right now, or a dollar a year from now. You don't have to think hard about that decision, because you know instinctively that the dollar that's right there, able to be instantly transferred into your sweaty little hand, is much more valuable. It can, in fact, be easily transformed into a dollar a year from now, by the simple expedient of sticking it in a drawer and waiting. It can also, however, be spent before then. It has all the good stuff offered by a dollar later, plus some option value.
Even if you're sure you don't want to spend it in the next year, however, a dollar later is not as good as a dollar now, because it's riskier. That dollar I'm holding now can be taken now, and then you will definitely have it. If you're counting on getting a dollar from me a year from now, well, maybe I'll die, or forget, or go bankrupt.
The point is that if you're valuing assets, and some of your assets are dollars you actually have, and others are dollars that someone has promised to give to you at some point in the future, you should value the dollars you have in your possession more highly than dollars you're supposed to get later.
