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Risk-free rates add £160bn to UK deficits

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UK - A move to a risk-free rate of accounting as proposed by the UK accounting standards board (ASB) would add over £160bn (€170bn) to UK deficits of the Aon200 companies alone, Aon's Marcus Hurd has warned.

The head of corporate solutions at Aon argued during a discussion about which discount rate should be used that market awareness is key for pension funds.

"The crucial lesson for pension schemes is to be clear about what they are targeting as well as fully acknowledging those targets that are deliberately not being pinned down," stated Hurd at the European LDI summit in Amsterdam earlier this week.

Addressing what he calls ‘moving target' risk, Hurd argued even if pension funds manage interest rate, inflation, equity, and mortality risk, they should pay attention to its targets.

"Recent experience in the UK has shown that a company hedging its liabilities on a pensions accounting basis will still have faced an additional £60bn deficit on a risk-free basis during 2008.

"In addition, the target is subject to change at any point, be it from a local country pensions regulator, or an accounting standards board. Crucially, in all cases of change, the scheme is left facing a deficit where previously one didn't exist," said Hurd. 


He also suggested pension funds should used derivatives to hedge out interest rate inflation risks, since the companies who adopted these strategies have found themselves in a far better position than those who have not.
 
Gareth Derbyshire, chairman of the National Association of Pension Funds' Accounting Standards Working Group and former managing director of the now-defunct Pensions Advisory Group at Lehman Brothers, commented aside from the discount rates, the ASB should look also at wider EU issues, specifically regarding presentation.

"It will be difficult to come up with a new pension accounting standard until that [presentation issue] is clear," he said in a panel discussion at the conference.

Eric Steedman, senior international consultant at Watson Wyatt, agreed, adding: "It is very hard to see how pensions should be laid out in accounts if it is unclear how the accounts should be laid out."

IPE understands the ASB is discussing the presentation issues in London today.

If you have any comments you would like to add to this or any other story, contact Carolyn Bandel on +44 (0)20 7261 4622 or email carolyn.bandel@ipe.com

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