The proposals put forward by the Accounting Standards Board (ASB) would involve changing the liability discount rate from the AA-rated bond yield to a risk-free rate, and removing the expected return on pension assets from company balance sheets.
“The ASB proposals are another dagger in the side of final salary pensions schemes,” said senior consultant & actuary Marcus Hurd of Aon Consulting. “According to our calculations, the changes would add approximately £120bn to the combined deficit of the UK’s 200 largest pension schemes.”
With equities and long-term interest rates falling, inflation expectations rising and increasing longevity, liabilities should be sky-rocketing, and some argue that discounting with the AA-rated bond yield - where the credit contraction has seen spreads over Libor balloon from 40 basis points to 120bp - masks much of that increase. “Pension funds have enjoyed a kind of diplomatic immunity – they haven’t had to report assets and liabilities in the same way as any other financial institution has to,” said Dawid Konotey-Ahulu of Redington Partners. “The ASB points out that the AA rate was originally elected because it was a harmonised number, and their conclusion is that current market discount rates should reflect the time-value of money only. Whether you agree with that or not, it’s well reasoned.”
In asset allocation terms, using a risk-free discount rate could remove the incentive to invest in bonds to match liabilities, in favour of absolute-return, Libor-plus strategies. As Charles Cowling, managing director of Pension Capital Strategies, suggested, taking the potential profits of pension schemes off corporate balance sheets could mean that “companies will see only downside risk and balance sheet volatility” from pension investments, triggering a flight from equities.
Another outcome could be “a surge in demand” for buyout solutions, he added.
Robert Gardner of Redington Partners pointed out that the yield on AA bonds is currently 6.2 per cent - well above the long-term swap market at 4.9 per cent and UK gilts at 4.6 per cent. The proposed risk-free rate would be lower still, and close to the buyout rate, which has historically been between Libor and gilts.
MS
