Pensions discount-rate smoothing to produce no more than 'one-off gains'
UK – Claims that giving UK companies the ability to select their pensions discount rate will relieve them of increasing deficits is "without merit", according to industry expert Con Keating.
A recent academic paper written by Brighton Rock's Keating, Ole Settergren of Sweden's Pensionsmyndigheten – the country's centralised pension administration service – and actuary Andrew Slater rejected calls for greater smoothing of discount rates and said the approach would simply produce "one-off windfall gains".
In 'A Financial Analyst's View of the Cost and Valuation of DB Pension Provision', the authors suggest the fund's internal growth rate (IGR) should be employed to measure its sustainability, instead of existing approaches to liability calculation.
They write: "The many alternatives in use (risk-free rate, Gilts, expected asset return) lead to over or underestimates, bias and volatility. The main reason for this is that they are exogenous to the system and do not reflect scheme arrangements and dynamics.
"The idea that both of these biases and variability issues can be resolved solely through the flexibility inherent in the choice of discount rate in current regulations is without merit."
Highlighting problems with existing approaches, the paper added: "It is apparent that the current mark to market standard is not an inconvenient truth, but a severely misleading and very costly fallacy."
The authors also argued that the IGR approach avoids such pitfalls by concentrating on pension contributions – currently overlooked in the present arrangements.
"The IGR enables accurate and consistent evaluation of the state of the pension system when applied to the income and expense projections," it added.
The paper argued that the IGR approach would be able to take account of precautions taken by sponsors and trustees – such as parent company guarantees, not included within the market value approaches.
"The IGR can be used to assess and compare pension system performance, and to measure the impact of management interventions such as liability-driven investment and closure of schemes to new participants," it said.
Keating, Settergren and Slater came out in favour of a revised statutory objective for the Pensions Regulator, subject to consultation alongside the introduction of smoothing.
A revised objective was proposed by a number of business and industry sources, including the National Association of Pension Funds and business lobby CBI.
The authors argued that such a new objective should come above the regulator's obligation to protect the Pension Protection Fund.
"As sponsor solvency is, in the absence of pension indemnity assurance, the prime determinant of the security of UK DB pension schemes, the effects of actions required of sponsors in support of schemes should clearly be a concern for the Pensions Regulator," they said.
Arguing that the approach should take "precedence" over its protection of the lifeboat fund, they added: "Such a responsibility would merely be recognition that a solvent sponsor is the best and primary security for members' benefits."
They said the introduction of smoothing could be seen as recognition by the government that errors were made in the past and that these should be corrected.
"This is simply recognition that the best is indeed sometimes the enemy of the good," the paper concluded.
"Smoothing would be good for schemes and the government, but the best would take time to introduce and implement."