Mark Twain once remarked ‘reports of my death are greatly exaggerated' upon hearing that his obituary had been published in the New York Journal.
In the pensions world, some commentators have also remarked that reports of the death of defined benefit schemes are also exaggerated. That may have a grain of truth in it, but more recently these claims have become more bullish. Thanks to the combination of rising equity markets and higher long-dated gilt yields, deficits are falling. Not only will DB schemes survive, they may even stage a comeback, according to the soothsayers.
I take issue with this because these reports of the almost rude health of DB schemes still don’t tell the whole truth and nothing but. The reason for this is that a deficit is only as good as the assumptions that have been made to produce it.
In defined benefit schemes, there are lots of assumptions and, therefore, plenty of potential for making a bad situation look good or vice versa.
One key assumption is the return on assets, particularly the return on equities because this is what DB schemes are heavily invested in. A high assumed return will make the scheme look like it is well-funded; a low return the opposite. Lane, Clark and Peacock’s annual ‘Accounting for Pensions’ survey reveals that schemes’ assumed equity returns (for only the 50 schemes surveyed) range from 6% to 8.5%. No prizes for guessing that the higher expected returns belong to schemes in the most precarious financial state.
How is this allowed to happen? Why are schemes allowed to make such a diverse range of assumptions about the rate of return on the same thing?
Pension accounting and deficit reporting needs to be tightened up. How are potential shareholders weighing up whether to buy share A and B supposed to judge whether the pension deficits reported by these two companies are comparable?
A greater worry is assumptions made about longevity. I was staggered to read recently that a major high-street retailer with a big defined benefit pension scheme was assuming that its 65-year-old male pensioners would live to just 83.8 years.
Insurers selling annuities today are assuming that a 65-year-old annuitant will live until 86 or 87. For what reason are this pension scheme’s members likely to live two or three years less than an insurer’s annuitants? I might be able to accept this difference if we were talking about steel workers or miners. But shop workers?
Lane, Clark and Peacock’s survey also estimates that the collective pension deficit for the 50 companies in its survey would increase by £41bn by adding three years to life expectancy.
News suggesting FTSE 100 company deficits had fallen to £31.8bn therefore needs to be taken with a bucketful of salt. This should be read as the collective deficit if, and only if, ex-FTSE 100 workers die long before everybody else.
Until schemes are forced to calculate deficits using assumptions within a pre-defined reasonable range (a job for the Faculty and Institute of Actuaries perhaps?), members won’t know whether their promised pension is safe and potential investors won’t be able to tell whether one company’s pension surplus is another company’s pension chasm.
Until that happens, reports of the resurrection of DB schemes are greatly exaggerated.
John Lawson is head of pensions policy at Standard Life.
The views expressed are those of the author and not those of the company he represents.IFAonline
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