A lack of communication about the funding status of defined benefit schemes could have the potential to lead to a "financial scandal".
During his presidential address as the new head of the Faculty of Actuaries, Stewart Ritchie, director of pensions development at Aegon, says more work needs to be done to ensure employees and employers understand the implications of shortfalls in DB schemes.
In his speech Ritchie says there are considered to be three things which need to be “aligned” in order to avoid a financial scandal: the legal position, financial position and consumer understanding of the scheme.
But he says at the moment there are problems if the industry regards the legal position for a DB scheme for a solvent employer as being 100% of buyout solvency, while the financial position is either a current funding position or the Pension Protection Fund (PPF) “subvention level” of around 70% of buyout solvency, while consumer understanding is “all over the place”.
“Then I think we can see there remains considerable potential for financial scandal in the area of private sector defined benefits,” adds Ritchie.
He points out it is “indisputable” that today there is “serious solvency problem for defined benefit schemes which do not enjoy a taxpayer's guarantee”, particularly as he says there is a “potentially large gap between even Financial Reporting Standard 17 (FRS17) and full buy-out” figures.
As a result he says he worries about the “fool’s paradise” of DB scheme members living in ignorance of what will happen should their employer become insolvent while the pension scheme is in deficit.
He says: “I do not believe this communication problem is too difficult to address. There will be those who argue that explicit disclosure of this nature will just worry people and lead employers to close down `good' final salary schemes even faster. To them I say that it is not worth fighting for something that can only survive in a fog of ignorance.”
In addition he says actuaries must play their part in finding and offering solutions to provide financial stability for schemes, with Ritchie suggesting if strong companies issue long bonds to fund their own pension fund deficits, the same bonds could also be suitable investments for other pension schemes.
He adds: “I am not convinced the bond shortage is insoluble. There are many other steps which individual employers can take to improve the security of their DB promises, but all of them have a price tag which the employer must be prepared to pay.”
Ritchie points out a financially strong company can raise capital at a modest premium over gilts, and if a company did that, another company pension scheme could buy some of the first company’s bonds rather than gilts.
And he points out: “If a hundred of the biggest and strongest UK companies did it, their pension schemes could have a wide range of high quality bond investments. The weakness of this idea is to serve the need of the pension funds the bonds would have to be of much longer duration than most commercial bonds, and perhaps also have considerable index-linking.”
Although he says investment actuaries and other investment professionals are beginning to come forward with partial solutions to this problem by creating liability driven and risk-sharing investment products, he suggest it would “surely be a significant help if there were a greater supply of investment-grade long dated company bonds”.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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