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Smoothing is a term used by accountants and actuaries to describe the legal process of dealing with changes in the value of a certain balance sheet entry or asset over a long period of time. By taking an average of all the different values, smoothing can deliver a constant figure for the shorter time periods that accountants and actuaries might need to consider.
At the beginning of 2013, the UK's National Association of Pension Funds, said a proposal to allow "smoothing" of gilt rates over two to three years, rather than using the prevailing rate, was not a good idea because once interest rates rose, schemes would be unable to take advantage of this in their valuations. The proposal from the Department of Work and Pensions in January 2013 had suggested that companies should be allowed to use the smoothed discount rate for liabilities.
A few months earlier, in October 2012, there was discussion over the use of smoothing to assess liabilities of US pension schemes.
It was reported that most public plans smooth their reported investment returns by taking an average of gains and losses over a number of years, typically three to five, but sometimes as many as 15. Moody’s, the ratings agency, was proposing to ignore this and take the most recent market value for the size of a pension fund.
Its raters would then impose a uniform discount rate, proposed at 5.5 per cent (based on Double-A corporate bond rates), when they calculate the size of promised benefits. The lower the number used, the larger those future payments look. So Moody’s estimate of funding gaps would be far more conservative – ie larger – than public pension funds that use a discount rate of 7 per cent or 8 per cent.