Glonal Crisis: Crises and Pension Funds

The current financial crises have spurred a lot of questions regarding pension funds management. Question such as how pension funds should be priced or how they should be used in times of financial and economic distress are some of the most important ones. Although the focus of concern has been on the private managed funds, probably because more information is available, it should be clear that reserves of defined benefits systems are subject to the same financial and political risks.
The following graph shows the assets under management in Chile, Costa Rica and Mexico in private accounts. As can be seen, the value of the assets has decreased substantially in Chile and México, and to a lesser extent in Costa Rica.

The accounting procedures, which establish that a mark to market algorithm for pricing assets should be used, explain most of this decline, although this decrease may represent real loses to persons that are close to retirement or to beneficiaries of survivor insurance.
The loses associated to mark to market in other financial instruments, for example, in the mortgage-backed securities, has led the Securities Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) to recently issue a joint clarification regarding the implementation of fair value accounting in cases where a market is disorderly or inactive. This guidance clarifies that forced liquidations are not indicative of fair value, as this is not an "orderly" transaction. Further, it clarifies that estimates of fair value can be made using the expected cash flows from such instruments, provided that the estimates reflect adjustments that a willing buyer would make, such as adjustments for default and liquidity risks. The use or not of cash flow vs. market value can have important effects not only on reported loses but on margin calls associated to derivative securities, just to mention one example.
We believe that in case of pensions the mark to market should be used even in disordered markets, for two simple reasons: i) for those not using their funds the market value is just an accounting value and it does not have other implications; ii) for those leaving the system, the market value is the amount used to calculate the annuities to which beneficiaries are entitled.