The financial theory of DB pension schemes - 18 years on from the paper that changed everything (in pensions)
Eighteen years' ago today, Jon Exley, Shyam Mehta and Andrew Smith published what has been described as the most important and influential paper ever written on defined benefit (DB) pensions - The financial theory of defined benefit pension schemes. Take a look back here.
In April 1997, many people thought DB pension schemes provided "something for nothing" - with the value provided to beneficiaries seeming to exceed the financial burden on the sponsoring company.
Most schemes invested in equities and the value of assets was most often based on an actuarial valuation approach - which commonly used dividend yields to calculate asset values.
Exley, Mehta and Smith's paper blew apart some of these views - analysing corporate pensions from the standpoint of modern financial theory and introducing an alternative approach to valuing assets using mark-to-market principles.
It proposed how this new market-based valuation discipline could be introduced and explained how this could be applied to pension schemes - openly challenging the status quo among scheme actuaries on how pension scheme assets should be valued.
The paper ultimately led to the adoption of pensions accounting standard FRS17 in 2001, the shift to a more liability-driven approach to DB investing and a move away from equities in favour of bonds.
Have your say
Do you agree with the findings of this paper? Were its conculsions correct? Has the move to mark-to-market valuations been a good thing? Were schemes right to invest less in equities and more in bonds?
Post your comments below or email [email protected] with your thoughts.
More on Defined Benefit
UPDATED: DB trustees must equalise GMPs in past transfers
Defined benefit (DB) schemes that provide GMPs must revisit and, where necessary, top-up historic cash equivalent transfer values (CETVs) that have been calculated on an unequal basis, a landmark court judgment says today.
FCA must stop DB transfer history repeating
Regulators must act now to impose some "proper regulation" to stop another defined benefit (DB) transfer advice disaster, saysTim Sargisson.
DB funds as an economic lever could derail schemes from responsibilities
Opportunities for defined benefit (DB) schemes to pursue investment approaches that help repair the UK’s economy cannot stand in the way of improving member outcomes, Aegon says.
DB transfer activity rises as 60% show signs of possible scams
More members transferred out of defined benefit (DB) pension schemes in October after September's record lows while values were surprisingly stable, according to XPS Pensions Group's Transfer Watch.
Funding negotiations in uncertain times
Joanna Smith says trustees will need to accurately identify if covenant issues are short-term affordability concerns, or the start of more material deterioration.
