This week we published the FAB index (FABI) which shows the way we see the state of this nation’s defined benefit pensions. “We” means First Actuarial, I work for First Actuarial.
We want to paint a picture of the pensions landscape. If you go to a gallery and look at a Turner or a Constable, you immediately recognise a unique sensibility. Turner looked at the sky one way, Constable another; the same sky -different eyes!
Two actuaries can look at a state of affairs and judge how it will turn out differently, because they have different assumptions. Some of those assumptions are minute- collectively, all the small assumptions can make a big difference- especially over time. But sometimes the assumptions are paradigmatic; meaning that two actuaries are seeing things from the opposite ends of a telescope.
The paradigm shift in the way that First Actuarial is asking you to look at the issue of defined benefit pension funding is away from a world where we want to stop paying pensions as soon as possible, to one whether we want to continue to support pensions over time. Those who want to stop paying people’s pensions are the trustees and sponsors of defined benefit schemes who want to buy out their liabilities (or see them transfer to the protection fund). Those who want to keep them open are trustees and employers who see a benefit in paying pensions to people to the very last payment due!
We are trying to encourage people to see the payment of pensions to the very last payment as being preferential; from a societal, economic and personal basis!
But there is a temptation among those in the opposite camp, to think that we are twisting the facts, frigging the numbers and hiding our assumptions to make our position look better than it really is.
Now you didn’t ask Turner or Constable to write down why he saw clouds the way he did but you can ask an actuary why he sees the future the way he or she does. So for all the people on this blog and for all the journalists and for the civil servants and for the actuaries in the opposite camp, here are the assumptions that lie behind the blue lines.
FAB INDEX–ASSUMPTIONS ; 18 OCTOBER 2016
The FAB Index is calculated using publically available data underlying the PPF 7800 Index which aggregates the funding position of 5,945 UK defined benefit pension funds on a section 179 basis, together with data taken from The Purple Book, jointly published by the Pension Protection Fund (“PPF”) and the Pensions Regulator (“tPR”).
The liabilities are calculated by switching the data underlying the PPF 7800 Index onto a set of assumptions derived using First Actuarial’s in-house “best estimate” assumptions (see below), and adjusted to allow for full scheme benefits.
First Actuarial’s in-house “best-estimate” assumptions as at 30 September 2016
The “best estimate” assumptions as at 30 September 2016 used in the FAB Index are described below. All of the assumptions exclude any allowance for prudence.
The discount rate is set equal to the weighted average of the expected future investment return on the assets actually held by the 5,945 DB pension funds included in the PPF 7800 Index, using the average asset allocation published in The Purple Book as weights.
As at 30 September 2016, the weighted average discount rate was as follows:
|Average asset allocation in total assets
Source: Figure 7.2, The Purple Book 2015, PPF and tPR
|First Actuarial “best estimate” expected return as at 30 September 2016|
|Gilts and fixed interest||47.7%||1.53%|
|Cash and deposits||3.5%||0.25%|
|Weighted average discount rate||100%||4.4%|
Other key assumptions:
|First Actuarial “best estimate” assumption as at 30 September 2016|
|Post-retirement mortality||100% S2PA
What should you make of that?
For the average Joe, like the Pension Plowman, it is hard to challenge these assumptions, because Joe has neither the data nor the analytic skills to do so. I expect that some actuaries will look at these numbers and challenge them as either too optimistic or too pessimistic, but there will be general accord that they are reasonable. Actuaries are reasonable people who do not take outrageous positions.
Why the blue line and the red line on the graph are so divergent is not because we are using different assumptions, not because we are looking at the world in slightly different ways, like Turner and Constable.
It is because we see the social purpose of funding these defined pensions as being positive to our society, economy, to our way of life. We don’t see these pensions as socially divisive , a limiter on growth or as obstructing personal financial empowerment.
In our opinion, the voices of those who want to see pensions level up to the quality of the best have been drowned by those who want them dumbed down to the worst. The risk transfer to DC has been badly handled so that we do now have a them and us culture.
In political terms , those “just getting by” aren’t getting enough of the pie and we’d like to see people looking at private pensions, the way we do – as making a meaningful contribution to people’s later life income. That cannot be achieved without efficient distributive structures (which these kind of pensions provide) or without a great deal of pay being deferred.
People and employers will not tolerate a great deal of pay being deferred unless they have confidence in the method of deferral. The Gilts + valuation methodology does not give employers that confidence, it just gives them big bills. It does not give people big pensions, it loses them their jobs.
The only way we can return to the days of confidence in pensions – is by having confidence that pensions work. Consigning pension strategies to the shackles of the gilts + funding methodology that drives the red line is to put not just our pensions but our aspirations in chains.
We see the world as we do, because we want the world we live in – especially the world we are going to live in – to be a better place.