While I understand the mathematics of DCF calculations where a lower discount rate leads to a higher valuation that seems like an absurd accounting methodology to use because we are talking about a liability is not an asset.
A liability is a negative asset. It would be quite inconsistent to allow assets to be valued via DCF and absolve liabilities from the same. The value of a liability is essentially the value that the debtor would need to pay to someone else to take the liabilities off the books. It is a perfect mirror to the asset value which is the value the same entity would need to receive in order to take that asset off the books. [Ignoring considerations like market frictions, strategic matters, etc.]
When you are talking about liabilities if interest rates go down you are paying less interest on your debt for variable rate products. Obviously a debt which has a lower interest rate payable is less of a burden/liability than a higher interest rate debt of the same amount all things being equal. As for fixed rate debts, while theoretically the value of the liability may rise if you want to buy out the debt (e.g. if it is a bond) at current market value you must pay above par, in reality does this actual happen for pension funds? If you own a a five year government bond paying 2% interest p.a. and interest rates rise and the price and value of your bond drops, if you hold the bond to maturity assuming no defaults occur your return will be 2% p.a. irrespective of what the bond price does in the interim. The reverse is also true, if you are borrowing and interest rates drop and the market value of the debt goes up, if you pay out the debt at maturity/par then the theoretical increase in the value of the liability does not affect you.
Liabilities for defined benefit pensions and insurance companies are not variable rate products. If interest rates fall, their present value rises. This is unlike a floating rate security whose duration is essentially zero.
The argument about mark to market holdings is used for banks around the place where "hold to maturity assets" are maintained at book value unless impaired. However, the market looks straight through this chicanery when doing sum of the parts valuations.
The only time when, for the sake of determining solvency, that not marking to market results in a fair representation of what happens is when the assets used to support the claims and liabilities/claims are perfectly matched. If so, interest rate movements do not impact surplus. Still the prices at which you could sell or buy the values on balance sheet are not a true and fair representation of the state of the insurance company, for example. Leverage calculations would be off, as just one example.
If interest rates move, the value of the bonds with duration moves. If the assets and liabilities are not perfectly cashflow matched, this has an impact on their solvency. If so, it needs to be represented. Even if you will get 2% on the bond if held to maturity, that 2% may not be sufficient to meet liabilities whose value has increased by more (assuming the duration of pension payments, for example, vastly exceed those of most bonds). By not marking to market, all that is happening in deferring the recognition that solvency has been weakened.
Solvency is changed whether or not the bond was trading above/below par before then, or at acquisition. All that matters is the valuation. Typically, superannuation funds trade their bonds in anticipation of interest rate moves, relative value arguments, and changes to the liability structure.
It seems like distorted accounting/logic to say that if interest rates drop a debtor is worse off, with the specific exception being a situation where they are forced to buy back/pay out the debt above par.
Whether a debtor is better off or worse off for a particular situation depends on their wider circumstances. An over-funded pension fund might benefit from the same event that an under-funded pension fund finds detrimental. However, given many pensions are underfunded in an actuarial sense, we see these types of effects.
I just can't get my head around the concept that declining interest rates are bad for a borrower/debtor (unless for some reason you must buy out the debt at market value above par). Do home home owners with a fixed interest rate mortgage panic when interest rates go down because the the net present value of the liability increased? That is absurd, if anything they will be happy that if rates stay low when their fixed rate expires they can rollover onto a lower variable rate. As for those with a variable rate mortgage they will be happy to paying a lower interest rate today.
Home owners are usually on variable rates. They will benefit is rates go down immediately.
Home owners who are on fixed rates will end up paying more than they could have. The present value of these represents an increase in the present value of their mortgage payments. Whether or not they choose to panic is up to them.
Perhaps a review of the accounts of QBE to see what occurs for general insurance liabilities and Challenger to see how they treat the life insurance liabilities may be helpful. The Australian Public Sector Superannuation Funds (CSS/PSS) would be instructive in relation to actuarial treatment of defined benefit funds.
In Australia, Australian Accounting Standard AAS 25 is relevant.
In each case, liabilities which represent the present value of future payments whose value does not vary with movements in interest rates, as might a floating rate note, are discounted by actuarial methods for presentation to the accounts and for solvency reasons under governing legislation (overseen by APRA).
Where the interest rate sensitivity of the liabilities is greater than those of the assets, a fall in interest rates across the curve will result in an increase in value of the assets, but less so than the liabilities being discounted. This will reduce surplus. It makes it less certain that assets will be able to cover liabilities. It is an accurate economic depiction of what is going on. If surplus is being eroded, this will further reduce capacity for mismatch risk. It leads to purchase of more 'risk free' bonds as mismatch is reduced where possible.
I can empathise that this all seems weird. It took me some time to come to grips with it. For my sins, I used to run these calculations once upon a time.
FT Article for interest:
View attachment Interest rate rise would fix pensions crisis — FT.pdf