I wrote earlier that defined-benefit pensions (the ones where you get paid a percentage of your salary inflation linked for ever on retirement) are fast turning into one of the UK’s biggest problems. The conventional view is that this problem is all about the funds not being able to ever fill their deficits, and hence ever meet their obligations.
A press release today from Nigel Green at deVere Group makes the point. Low gilt yields have increased the transfer value of defined-benefit fund. Ask to forfeit your stream of future payments for a one-off payment now and you’ll get more than you expected; that’s good for you, but bad for the fund (which no longer has that case to invest).
The same falling gilt yields are driving up the pension deficits themselves (the difference between the fund’s calculations of its assets and its liabilities); most pension funds assume that their future returns will mirror that of gilt yields so the more they fall, the lower that returned assume and the higher the shortfall looks.
It is all awful, and I agree that it is awful. But not in quite the same way.
The first thing that I see as awful is not the deficits themselves but the damage that the attempts to fill the pension funds are doing to the UK economy. Every pound poured into a gilt is a pound not poured into real investment for long-term corporate sustainability.
The second is that the deficits the pension funds are in such a twist about aren’t real; they are instead, in part at least, a result of an accounting obsession. Trustees, desperate to avoid being blamed for future problems, have become obsessed with matching their liabilities to their holdings – so they slavishly use gilt yields to measure their deficits and slavishly pour as much cash as possibly into miserably yielding bonds instead of productive equities.
This isn’t necessary. Let me repeat that. This isn’t necessary (subscribers can read my interview with Ros Altmann on the subject here). It is perfectly possible and legal for funds to focus instead on a more diverse group of investments and – in particular – to focus on cash flows from investments rather than the overall return from investments (it is, after all, cash that you pay pensions in…).
I’m not alone in thinking this; my column on the matter for the FT has prompted a wave of correspondence (from companies frustrated with the demands of their pension funds, from pensioners concerned their benefits will soon be cut as their funds collapse, and from pension trustees maddened by the stick-with-gilts advice from their advisors). I’ll be writing more on it.