Con Keating | Comment


The Pensions Act 1995, Section 75, obliged sponsors to pay the full cost of scheme buy- out on discontinuance. Justification was to stop sponsors “walking away” from their obligations. However, it had a far more del- eterious effect on corporate finances. In insolvency, the pension scheme claim is greatly inflated, to the detriment of credi- tors of equivalent or lower class. This legis- lation runs counter to the fundamental principle of equity in commercial affairs. Section 75 does not, in itself, alter the fund- ing obligation of an ongoing scheme but the Pensions Act 2004 does, introducing the statutory funding objective that scheme assets should be sufficient to cover techni- cal provisions.


These are fleshed out in the 2005 Occupa- tional Pension Schemes (Scheme Funding) Regulations: “The principles to be followed under paragraph (3) are:


ditions at the time of discontinuance. The determinant would be whether investment opportunities at that time were higher or lower than those originally promised by the sponsor in the pension awards. In contrast, today’s mantra says fund trus- tees’ duties are to pay pensions in full and on time. We should note the emphasis on accrued rights, which contrasts with cur- rent practices of using the discounted pre- sent values of projected pension benefits. The fund is collateral security for members’ rights, with its investment performance serving to defray the sponsor’s cost of provision. With the fund as collateral security, valua- tion at market prices is appropriate. If the fund existed to fulfil the pension service role, it would be necessary to consider its future income and price performance in its valuation.


(a) the economic and actuarial assumptions must be chosen prudently, taking account, if applicable, of an appropriate margin for adverse deviation; (b) the rates of interest used to discount future payments of benefits must be chosen prudently, taking into account either or both: (i) the yield on assets held by the scheme to fund future benefits and the anticipated future investment returns, and; (ii) the market redemption yields on govern- ment or other high-quality bonds…” There’s a lot going on here. The concept of prudence in estimates takes a fund-centric view; such biased estimates would have no place in a sponsor company’s accounts. Introducing prudent bias in the discount rate is profoundly unscientific. In modern English usage, prudence is vir- tually synonymous with cautiousness and reluctance to take risks, far from its original meaning, which was the ability to govern and discipline oneself by reason. It can


descend into reckless excess and even the vice of cowardice, now an apparent feature of much professional advice.


The counterfactual nature and failings of mandated discount rates are discussed at length


elsewhere, as the International


Accounting Standards Board (IASB) observed when dismissing using the e xpected rate of return on assets: “The fact that a fund has chosen to invest in particu- lar kinds of asset does not affect the nature or amount of the obligation.


“The measurement of the obligation should be independent of the measurement of any plan assets actually held by a plan.” Interestingly, the IASB does discuss the correct approach in several of its ‘Basis for Conclusions’ on IFRS 9’ documents pub- lished in 2014, which it describes as: “The original effective interest rate is the rate that exactly discounts the expected cash- flows (before deducting expected credit losses) of the asset to the transaction price (i.e. the fair value or principal) at initial recognition.” We have described this rate (for pension liabilities) as the contractual accrual rate and noted it is time consistent – accrual and discounting at this rate return the same amount. If a scheme is overfunded relative to best estimate or technical provisions, this reduces its claim on the sponsor in insol- vency, but also reduces the assets available for distribution among all creditors, and operates to their detriment. As long as these values are small, creditors and insol- vency administrators are unlikely to take action. But, when values are large, as they would be when schemes pursue self-suffi- ciency or buyout long-term funding strate- gies, now being promoted by The Pensions Regulator, push-back by administrators and creditors through the courts seems inevitable.


Issue 83 | April 2019 | portfolio institutional | 17


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