“Expected returns don’t pay benefits, cash does”
Anthony Hilton recently wrote a stinging attack on pension consultants -like myself- who advise defined benefit pension schemes to measure, and hedge, their liabilities with reference to gilt yields.
Here’s one (of several) reasons why he’s wrong.
His argument – that you could fund based on the much higher expected returns on risky investments – might perhaps be justifiable in a world where all corporate sponsors were rock solid and would last forever (clearly we do not live in this world – and even then it would expose companies to some needless nasty surprises along the way, but anyway).
However this completely misses the point that a major reason we fund pensions at all is precisely to provide security in a situation where the corporate sponsor ceases to be able to make payments itself. The reason we need to measure deficits is to get a picture of how secure the benefits might be in the absence of the employer, and to take corrective action (eg topping up contributions) if the situation is off-track, before it is too late.
And in those situations of sponsor company failure, we would hit a major snag under Mr Hilton’s approach: it’s hard cash that must be used to secure the benefits – Mr Hilton’s expected returns won’t cut it I’m afraid. Just ask the pensioners of BHS scheme, or indeed the allied steel and wire groups, still campaigning for their pensions over a decade later. This second example pre-dates the Pension Protection fund, so thankfully pensions today are better protected, but the conclusion for scheme funding – that you can’t rely on high future expected returns to discount liabilities – remains valid.
Pensions need to be paid to members in real cash, and it flies in the face of both accepted theory, and common sense, that the amount of money needed to provide these benefits can be reduced depending on the assets held to deliver them.
Today’s unfortunate reality is that the defined benefit system in the UK is on average chronically under funded compared to the benefits it has promised. Time and effort would be far better spent on considering the tough choices that might need to be taken, rather than on attempts to deny the existence of a problem in the first place.
Unfortunately Mr Hilton’s ill-judged remarks from an otherwise respected journalist damage the hard work that many of us in the industry have been doing for many years to try and secure the benefits and financial futures of those members dependent on defined benefit pensions for their retirement.
4 thoughts on “Why Anthony Hilton is Wrong on Pensions ”
There is a longstanding debate over the discount rate to use to measure deficits. I doubt we are going to resolve it here. But the argument in this article strikes me as missing a key element.
Yes, of course we fund pensions because the employer might become insolvent. And, yes, it’s not possible to “rely” on an expected rate of return. But how does that point to a bond discount rate if the assets aren’t invested in bonds? It’s a leap of logic that the author doesn’t explain. Other writers have bridged that gap. I don’t agree with their argument, but at least they have developed a reason. This argument doesn’t seem to try.
The author tells us that “it flies in the face of both accepted theory, and common sense, that the amount of money needed to provide these benefits can be reduced depending on the assets held to deliver them”. Well, consider this simple, common sense test. Imagine that a pension fund sold all its assets and put the cash under a (very big) mattress. Does that really not change the amount of money needed to pay the benefits? Is it really OK to make a calculation based on the assumption that the funds are invested in bonds, but then invest them in a vehicle with a lower return (actually no return at all)?
For a much fuller analysis, with logic, common sense and a bit of economics reduced to simple language, see http://www.simoncarne.com/wp-content/uploads/truth.pdf.