Transsubstantiation – more from Con Keating on DB funding!


Con Keating has produced a remarkable blog on the issues around DB funding –Anthony Hilton’s original piece continues to make waves it has received more comment – this is Con’s response. If you cannot access Dan Mikulskis’ comments via the link, they are appended to Anthony’s article

Doubtless Dan Mikulskis and his colleagues are sincere in their beliefs; the fervour of their defence of them is positively religious, and likely as well-founded an ideology.

Social psychologists use the theory of motivated beliefs to explain such behaviour. Motivated beliefs are quite distinct from the sociologists’ intrinsic and extrinsic motivation, which figure prominently in the analysis of trust.

Here, people still pursue their self-interest but may have multiple and sometimes conflicting goals. To quote Epley and Gilovich: “People generally reason their way to conclusions they favour, with their preferences influencing the way evidence is gathered, arguments are processed, and memories of past experience are recalled. Each of these processes can be affected in subtle ways by people’s motivations, leading to biased beliefs that feel objective (to them)”. As Oxford’s Tim Taylor has pointed out “The crucial point is that the process of gathering and processing information can systematically depart from accepted rational standards because one goal— a desire to persuade, agreement with a peer group, self-image, self-preservation—can commandeer attention and guide reasoning at the expense of accuracy.” There is more: “A person who recognizes that a set of beliefs is strongly held by a group of peers is likely to seek out and welcome information supporting those beliefs, while maintaining a much higher level of scepticism about contradictory information.

In this world view, control of the narrative and the suppression of progressive, ‘difficult’ journalists are routine.

Dan begins with the assertion that we face an “unprecedentedly difficult macroeconomic environment”. We face no such thing. In the 1970s we faced three-day working weeks, rolling electricity blackouts, petrol shortages and millions of days lost to strikes. There was serious, if sotto voce, talk of a military-backed coup; sterling required exchange controls and an IMF bail-out.

Private sector non-financial companies saw their returns on capital fall as low as 4%, in a year when inflation exceeded 12%. The FT index reached a low of 146, down 73% from its high. Gilt yields reached 17%, inflation over 20%. DB schemes had 11.4 million members, and their longevity was already increasing at post-millennium rates. Of course, there was a banking crisis, but no pensions crisis.

Since then, the rate of corporate insolvency has fallen dramatically, from nearly 2% annually to a recent 0.4%. Reassuringly, this means that the need for the PPF has never been lower. His assertion that sponsoring companies “face tough choices” when private sector returns on capital exceed 12% p.a. and dividend payments are an all-time record high has ‘truthiness’ but no more.

Dan takes exception to the idea that the discount rate should reflect the expected return on assets; so do I. In fact, Jon Danielsson and I, in meetings with regulators and in the columns of VOX-EU, argued extensively against the introduction of the ‘matching adjustment’ to the discount rate used in life company regulatory evaluations. Our views did not prevail, which means that there is an argument here, not used by Anthony Hilton, for a level playing-field.

But the use of gilts or AA corporate bonds is equally inappropriate. The use of a particular discount rate does not result in the transfer of the properties of the asset class from which it was derived to the pension liabilities being discounted. Using a risk-free rate does not confer risk-free-ness; that would require belief in financial transubstantiation.

In fact, as the concern is with corporate insolvency, the appropriate discount rate should be bankruptcy-consistent (admitted claims), not market-consistent. This rate is determined, at time of award, by the contribution made and the benefits promised. It is extremely stable, moving only as benefit projections are revised. It is part of the promise made by the company. Most importantly, it is equitable to other creditors. It paints a very different picture from gilt yields.

The obvious problem with assertions such as “Today’s unfortunate reality is that the defined benefit system in the UK is on average under-funded compared to the benefits it has promised”, is their self-referential circularity. This may be true under the current protocol, but lacks objective, independent supporting evidence. With a little more thought, we can see it is actually support for the use of the sponsor-promise based metric.

No charity is afforded journalists; the narrative has taken hold. It is past time to correct this, but, make no mistake, the motivated beliefs are well-entrenched.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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5 Responses to Transsubstantiation – more from Con Keating on DB funding!

  1. George Kirrin says:

    Henry, I’m just puzzling why Redington seem to be coming out wholly on the other side of this necessary debate – first Dawid, now Dan?

    In the latest opinion piece, Dan simply skips over “liabilities …. calculated with reference to gilt yields (as has become standard practice)” and sets up a more extreme contrast with “risky assets” and “high future expected returns”.

    I’d prefer the actuarial profession to take a more balanced position somewhere in-between, by reference to “prudent expected future returns”. Instead of “gilts plus”, how about “best estimate minus”, with a large margin of prudent safety? Remember that “best estimate” to an actuary or a marking-to-market accountant has only a supposedly 50% likelihood, however they calculate it.

    And like Con, I certainly wouldn’t support discount rates based on “best estimates” or “expected returns” which haven’t been seen since the heady days of the last century.

  2. andyjags says:

    The legislation on discount rates is happily as George supports. Prudent chosen assumptions in the light of the expected return on the assets. Or can be gilts based and I would suggest that applies when targeting something like buy out.

    • George Kirrin says:

      Agreed, and trustees should monitor both, or only the latter if buy out is planned in the short to near medium term?

  3. henry tapper says:

    George, there’s a great challenge to these received ideas , not just in Anthony Hilton’s piece but in the work practicing actuaries. It’s good do see the debate kicking off but we need more data – better presented – before trustees and employers can get the full picture. Hopefully that’s what arguments like this can develop into.

    • George Kirrin says:

      Not sure what you mean by “more data”, Henry.

      The UK’s had a “scheme-specific” regime since 2004, so trustees (and their advisers) and employers (and their advisers) should have mapped out their funding requirements several times by now.

      If they haven’t it’s because too many of the advisers are being herd-like not client-specific, and also because many of the trustees and/or the employers do not appear to have a clue/plan/understanding of expected cash flows (take your pick).

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