In one week in January, the fall in gilt yields wiped out all of the FRS17 improvement in pension scheme deficits that had taken place throughout 2005. In one week, a twitch in long gilts - where the supply of stock is artificially low - offset all the good work that had been done in the previous 52.
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.
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