Andrew Sawers

The biggest problem was that the present value of long-dated liabilities that pension schemes bear increased with the fall in the gilt yield used to discount those liabilities back to today. So regardless of how much pension funds’ assets had managed to fill in the deficit holes, they were already lagging a growing burden of liabilities.

Many readers are painfully aware of all this. For others, the sensitivity of pension liabilities to movements in the gilt market may come as something of a surprise. There are all sorts of people to blame for the problems this ‘gilt trip’ causes. There’s the accountancy standard setters, of course, who obliged us all to put scheme liabilities on the corporate balance sheet (SEI Investments has produced a very interesting paper on the flaws of FRS17). The government crystallised the liabilities by ensuring companies couldn’t walk away from their pension obligations. Then there is the requirement to close the funding gap within ten years, even though the obligations may extend out to 30 years from now. Pension scheme liabilities are actually a long series of cash outflows, not a single bullet repayment needing a silver bullet solution.

But the real problem is the rush to fund a liability measured using a gilt yield – with gilts. Our own survey with Jardine Lloyd Thomson last month and another one from the NAPF point to a major shift towards an asset class that can’t offer the growth that’s needed to turn savings into wealth. Only equities are capable of breaking out of the zero-sum game and offering the necessary returns over the timescales involved. Companies don’t match their assets and liabilities by borrowing money and funding the repayment by sticking the cash back in the bank. Likewise, a gilt-related pension liability ought to be financed by investing in the growth of the corporate economy.

Footnote: Aon Consulting warns that parliament’s decision to ban smoking in pubs will adversely affect our pensions problem because people could live anywhere between 5.5 years (men) and 6.8 years (women) longer by giving up the fags.