Raj Mody thinks we need to take a new approach to assessing scheme health
As a pensions industry, are we overly obsessed by deficits? That might sound like a counter-intuitive challenge to both sponsors and trustees. Many trustee boards will be watching the deficit or funding ratio as a key healthcheck indicator. Meanwhile, many sponsors will have to contend with having to explain, or explain away, various deficit measures including accounting standards to analysts and shareholders.
Really, though, the deficits don't matter, or at least don't matter as much as the air time we give them. Sure, it's an easy measure for someone outside of the pension scheme situation to readily access. For someone on the inside of a scheme, it is also an easy reference – easily provided and regularly updated, and required to be reviewed anyway with at least annual frequency.
To add to that, the industry loves commentating on deficits, whether on individual schemes or in aggregate. At least once a month, some consultancy will make some pronouncement about the state of defined benefit (DB) schemes, by reference to deficits.
Without an in-depth understanding of the cashflow picture, as well as how it changes under different conditions, you'll have little chance at making the right decisions you need to around financing, asset strategy and risk management.
But still none of that means it matters. If you went for a routine medical check-up it wouldn't necessarily be right to send you off for an intrusive series of further interventions just because your blood pressure readings were off the mark on that occasion. Nor would it be right if the doctor sent you home with a smile on your face purely because your blood pressure was normal, without regard to other checks. Equally, if you went into hospital feeling very unwell, you still might have perfectly normal blood pressure readings. An assessment of your health is a lot more complicated than the simplistic measure of blood pressure.
How to measure scheme health
DB schemes continue to represent a multi-decade long problem, even with so many of them closing. For the industry to start solving that problem properly, we need to see through meaningless measures.
For a start, an actuarial 'valuation' is a misnomer. The label can give a false impression – even to and maybe especially to financially literate users – that the numbers coming out of that exercise in some way represent the truth. It sounds like some kind of objective assessment, and a reliable basis for action, which it often isn't.
In the same way that a human body is a multi-variate organism – there's no point regularly monitoring just blood pressure alone – a pension scheme is complex. Of course you have to start somewhere but in my view, the better place to start than single-point measures like deficits or funding ratios is the cashflow profile over time.
Ensure you understand the timing profile of inflow from assets and external funding, alongside the outgo of your liability obligations. I think there are many situations where this analysis is not given sufficient focus and priority. But without an in-depth understanding of the cashflow picture, as well as how it changes under different conditions, you'll have little chance at making the right decisions you need to around financing, asset strategy and risk management.
Nowadays, improved calculation technology, just as with improved science in the medical arena, means that it should not cost schemes any more to have this information at their finger-tips. The extra information is akin to doing a proper blood test – readily available, cost-effective and gives the user much more relevant insight.
The legacy DB situation, whether private or public sector and whether in the UK or internationally, is what it is. Historically, the treatment for high blood pressure consisted of reducing the quantity of blood by blood-letting, or using leeches. Let's make sure the pensions industry doesn't drift through its challenges with bygone techniques.
Raj Mody is head of pensions consulting at PwC
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