Letter to FT re defined benefit pension scheme funding
I wrote this letter on 15 February 2015 – as yet unpublished – to the FT after it had published two misleading pieces on defined benefit pension scheme funding. In the light of the CEO of the Pension Protection Fund’s reported statement on the risks members of such schemes are exposed to given their large deficits then I suggest the FT re-considers the subject.
You have now printed two large pieces of biased commentary on defined benefit pension scheme liabilities that contain major factual errors. I refer to Neil Collins’ article on 7 February and Mark Tennant’s letter in response published yesterday.
Mr Collins refers to the method of comparing the market value of a pension scheme’s assets with the present value of its liabilities discounted using corporate bond yields as the “madhouse of actuarial mathematics”. The method is mandated by international accounting standards for private companies to use in their accounts. It was introduced in the UK between June 2001 and June 2003 under a new accounting standard known as FRS17 after being consulted on in November 1999. Actuaries are simply obeying orders and doing the A level sums involved. Most actuaries objected to its introduction back in 1999.
Mr Collins’ deeply flawed logic to take the money and run is dangerous without detailed case by case examination. If it is followed by huge numbers of defined benefit members in taking a woefully inadequate sum of money to give up their pension rights then there will be two consequences.
1. There will be a massive boost to many companies’ balance sheets and cash flows
2. In the near future, a colleague of Mr Collins will be writing about the biggest financial mis-selling scandal to hit the pensions industry
Mr Tennant is in a significant muddle over his history & timeline. The actuarial profession was largely using the dividend discount method up until 2003 and in some places for even longer. The phoney surpluses he refers to in the 1980s and 1990s were calculated under the method he wishes to return to.
The actuarial profession was too blind to market values of pension scheme assets and liabilities for too long. Many companies missed the chance to de-risk their balance sheets for example in 1998 when bond yields of 9% were sufficient for many pension schemes to cover their liabilities without equity risk. The actuarial profession was slow to react to improving longevity and to adjust its long term return expectations to a world of low inflation driven by central bank monetary policy.
The methods under attack require the real value of assets actually held to be compared with the cost of financing the liabilities one owes using the real rates for corporate debt. If they had been in use in the 1990s then we almost certainly would have smaller pension scheme benefits and liabilities now.
When I’m driving my car, I’d rather know what size of hole I have to navigate than to imagine it is a small pot-hole rather than a crevice that would swallow up whole the car.
It wasn’t just the accountants who drove the major changes in the early 2000s. DWP regulations announced by press release on 11 June 2003 required the company to pay the pension scheme deficit in full (as though placed with an insurance company) were the scheme to close. Actuaries’ attitudes to pension scheme funding had to change as the scheme’s benefits were no longer a discretionary promise to use reasonable endeavours to provide but a huge, enforceable corporate debt.
Today, the cost of securing pension scheme liabilities is unaffordable by many UK companies without taking a risk on the future returns on equity investments. If the gamble fails then shareholder value will be destroyed first followed by future pension payouts and corporate debt will struggle to be repaid.
The UK pension regulator allows this to happen to varying degrees, hoping no doubt that the gamble will work out over the longer economic cycle. EU regulators seem less sanguine and more stringent reporting standards may follow. These points of basic corporate finance and accounting ought to be known and understood by all Financial Times readers and not demonised as ‘actuarial madness’.
Fellow of the Institute of Actuaries