Pension deficits aren’t real – here’s how to fix them

One of the biggest worries in the West has long been pension deficits. How we ask, over and over, will we ever manage when our defined-benefit pension funds are £530bn in deficit?

The consensus answer is that we will manage by forcing companies – the sponsors of these schemes – to pay huge amounts of money into the funds in a seemingly endless attempt to cut the deficits to reasonable-looking levels.

Doing so might put the survival of some firms at risk; it might mean a fall off in capital investment and productivity; and it might even be one of the factors holding down wages in the UK (the pension fund takes priority over the workers). But there it is. The pension beast must be fed.

At MoneyWeek we have often wondered if there isn’t an easier answer. Why not just change the inputs to the deficit calculation? Most funds calculate their deficits with reference to the UK’s historically low gilt yields or AA rated corporate bonds (ie, they assume that their long-term returns will be minute).

But they could just as easily use the expected return on a well diversified portfolio of assets. This would be higher, the expected long term value of the fund would then be higher and the deficit lower. How easy is that?

There is another number pension trustees could change that would do them just as well – the longevity numbers. The latest life expectancy analysis – from the Continuous Mortality Investigation (CMI) – shows that we are no longer seeing the same rates of improvement in life expectancy as we did at the turn of the 21st century. Yet most pension deficit calculations assume that we will keep living longer and longer.

Correct this to account for current trends*, says PwC, and some £310bn could be “wiped off” the current £530bn aggregate pension deficit, leaving a mere £220bn. Then add 1% a year to return assumptions (which is really not remotely punchy) and you will have dealt with the rest “without needing company cash contributions”.

To non-accountants this all sounds ludicrous. But it isn’t. Pension deficits aren’t real – they are just functions of trustee assumptions about far-off futures. Those assumptions can and should be challenged – fantasy deficits matter to individual company sponsors, but given the possible effects of diverting cash from productive use to pension-deficit-plugging use, they matter to the rest of us too.

* Assume men will live to 84 rather than 90 and women will live to 86 rather than 91.


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