Pension deficits aren’t real – here’s how to fix them

One of the biggest worries in the West has long been pension deficits. How we ask, over and over, will we ever manage when our defined-benefit pension funds are £530bn in deficit?

The consensus answer is that we will manage by forcing companies – the sponsors of these schemes – to pay huge amounts of money into the funds in a seemingly endless attempt to cut the deficits to reasonable-looking levels.

Doing so might put the survival of some firms at risk; it might mean a fall off in capital investment and productivity; and it might even be one of the factors holding down wages in the UK (the pension fund takes priority over the workers). But there it is. The pension beast must be fed.

At MoneyWeek we have often wondered if there isn’t an easier answer. Why not just change the inputs to the deficit calculation? Most funds calculate their deficits with reference to the UK’s historically low gilt yields or AA rated corporate bonds (ie, they assume that their long-term returns will be minute).

But they could just as easily use the expected return on a well diversified portfolio of assets. This would be higher, the expected long term value of the fund would then be higher and the deficit lower. How easy is that?

There is another number pension trustees could change that would do them just as well – the longevity numbers. The latest life expectancy analysis – from the Continuous Mortality Investigation (CMI) – shows that we are no longer seeing the same rates of improvement in life expectancy as we did at the turn of the 21st century. Yet most pension deficit calculations assume that we will keep living longer and longer.

Correct this to account for current trends*, says PwC, and some £310bn could be “wiped off” the current £530bn aggregate pension deficit, leaving a mere £220bn. Then add 1% a year to return assumptions (which is really not remotely punchy) and you will have dealt with the rest “without needing company cash contributions”.

To non-accountants this all sounds ludicrous. But it isn’t. Pension deficits aren’t real – they are just functions of trustee assumptions about far-off futures. Those assumptions can and should be challenged – fantasy deficits matter to individual company sponsors, but given the possible effects of diverting cash from productive use to pension-deficit-plugging use, they matter to the rest of us too.

* Assume men will live to 84 rather than 90 and women will live to 86 rather than 91.

  • Jonathan Tedd

    My generation (Gen X) don’t look very well at all, vastly overweight many are predeceasing their parents.

  • smspf

    Logan’s Run did come up with another solution.

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  • Andrew Crow

    We do tend to have an almost childlike faith in numbers because we are taught to believe that they represent precision.
    In reality this makes figures particularly suitable instruments for lying and dissembling – hence the the old saw about ‘lies, damned lies and statistics’.
    A tissue of lies remains a tissue of lies whether it is expressed in words or in numbers.
    In finance and economics we have to rely on the same instincts for what might be true as our forebears did in the sphere of religion.
    In the matter of pension provision we don’t have to wait for death to find out whether we guessed right; we find out when it’s time to retire and we discover whether we can afford to.

    • marylyn ford

      Give me a set of numbers and I will make them mean whatever you want!

      • Andrew Crow

        Bet you can’t make my income and expenditure mean I’m wealthy !!

        • marylyn ford

          Wealth is comparative, and compared to anyone in India, doing your job for the local wage, you are wealthy beyond their dreams. Statistics are not bothered about how the figures are derived, that is why you have compliance departments instead of a set of rules that makes this kind of sophistry almost impossible.

          • Andrew Crow

            You’re not wrong, Marylyn. My comment was just like a joke taking your jibe at statistics literally.

  • Michael T

    Good points in this article.

    Unfortunately, cash injections aren’t the only way that the assumed deficit is “fixed”.

    They also: delay retirement dates (e.g. increase from 60 to 65 as normal retirement date); increase contributions from members without increase in benefits; reduce the benefits that can be earned during future years of service.

    If the assumed deficit is discovered to be unfounded and just based on poor assumption, many have already been badly penalised (reduced pension) perhaps unnecessarily(?)

    Before people without DB schemes jump in with the usual green eyed monster responses, just consider how similar this all is to the state pension which after all, is a DB but just state run.

    If there is a difference, it may be in the way the assets are managed to fund the scheme? I’m not sure what the assigned assets are that are specifically allocated to fund the state pension?… but presumably they are managed and monitored to identify deficits similarly (?).

    So is the “can we afford the triple lock” conundrum based on similar potentially unreliable statistics?

  • Peter Edwards

    Funny article, so because the measure that has been used for decades does not fit the bill, Pension funds should diversify more and put their clients funds at more risk.
    It all seems pointless to me as defined pension are rare these days and all asset classes seem overvalued.

  • Paul Entwistle

    Probably all true, but of course it follows some decades (before 2000) when the opposite occurred – I.e. Returns were overestimated and life expectancy forecasts were way behind. Either way, don’t tell Philip Green till we’ve banked the cheque.

  • Dave Caldwell

    Article means triple lock should stay and we should revert the pension age to 65 i.e honour the conditions of the National Insurance scheme I joined..