Insider Business Club: Crisis? What crisis?

Are companies right to be re-examining final salary pension schemes?

Tony Osborn-Barker, actuary and strategic asset & liability
manager at Deloitte

Pensions risk is not necessarily a risk that companies should be taking on.
To appreciate that one only has to be involved with any sort of budgeting
process that would have to cope with vast swings of that magnitude.

I think one of the issues that has come to the fore in recent months is that
big decisions need to be made by companies as to whether this is a risk that
they want to maintain.

Is it possible for them to somehow outsource it? Can they just take the risk
off the table? Clearly they would not take risks of this magnitude in any other
part of their business.

Obviously people are looking at much safer alternatives and this would
probably be more consistent with most companies’ practices in other areas.

I can’t think of any other expense that a corporation faces, where they would
actually look to invest using the mindset of thinking it would reduce the cost.

Yet that is what has persisted with pension funds over the past 15-20 years.

One of the big changes that we have seen in the past 12 months is a much
greater conservatism in both actuarial and accounting practices and greater
transparency in terms of marked to market valuations.

But over the past six months, we have got to a stage where a degree of
normality has returned to market. There are three crucial issues and three
fundamental risks.

The three crucial issues currently are cash flow matching, deficit repair and
the prospective threat of surplus management. On the risk side are interest
rates, inflation and the impact of mortality.

Are pension protection levies too high? Could the collapse of one
extinguish it?

Ben McDonald, director at KPMG

In terms of the levy being large, that is based on the expectation that the
claim will be large. The key point there is whether the levy is unfair for, if
you like, low risk companies.

Inevitably, there is some bias within that and there is some cross subsidy.
The reason for that is another criticism of the levy itself.

The companies that can least afford to pay were being asked to pay the most,
because they were the highest risk, which is how insurance works.

That said, the sentiment within the industry has been that the pension
protection fund is a good thing and that we don’t know whether we are going to
need it at some point, because things do change.

As an industry there is some acceptance that even though we don’t feel we
will ever end up in the pension protection fund, we accept that we are going to
have to pay a substantial levy to it.

Picking up on the second point about whether one large claim could leave the
pension protection fund extinguished, it is a risk and I am sure that those in
charge are aware of that risk and model it.

One has to hope that within their levy calculations there is reserving for a
rainy day. We don’t want to find ourselves making good that shortfall forever,
but that is the way that the fund operates and I don’t think that can be

One of the things getting in the way of those companies managing their way
out of a difficult position is the emphasis on the short term. Recent
legislation has driven us towards thinking about things over periods of five or
10 years. Sometimes, you need to think over the long term what is the best way
for this pension scheme to meet its obligations.

Are FDs too cautious when making pension fund investment decisions?

Jerome Melcer, senior consultant at Lane Clark & Peacock

Unless they are also a trustee of the scheme, they are not really in the loop
when it comes to the decision making process. That can be a problem because FDs
are sitting in a position where it is they who actually suffer the deficit that
comes out of poor investment decisions by the trustees.

At the moment, FDs only join the loop at the point where trustees set out
their statement of investment principles. The FD will feed back their views, but
the trustees don’t need to listen to them. I think there is a real asymmetry in
terms of the responsibility here, by actually having to carry the buck for
things that go wrong.

What we will probably see going forward is that under the new regime of
funding when trustees and companies negotiate what fund should go into the
scheme, that is the situation where the FD will say: ‘Well, actually I will be
able to fund that gap in x years to the level that you want. But if you want me
to do that, we would like to be better protected from downturns in equity
markets.’ Despite the edging away from equity portfolios in the past couple of
years that has been reported in the press, the actual effective change in the
equity allocations is relatively small.

More than 50% of most defined benefit schemes assets are still actually
invested in equity portfolios. This is not really diversification in the truest
sense. With finance directors looking forward, now we have an opportunity to try
and force some best practice upon trustees in terms of moving forward.

Readers’ questions were put to our experts by editor in chief Damian Wild

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