Plugging phoney deficits does no good!


We have become fixated with phoney pension deficits, now a British pension consultancy is suggesting we can plug phoney deficits with real money, the dividends that support “other people’s pensions.

This is what we think of the phoney deficits. Our best estimate of the black hold is that there is (in aggregate) no black hole at all. In December we actually ran a pension surplus of £270m. Infact we can’t find a single month since the  start of our analysis (March 2006), when UK DB pensions haven’t collectively been in surplus.




Slashing dividends to plug notional deficits is as futile as Don Quixote tilting at windmills. If these deficits exist, and we would argue that they are but a product of the favoured minds of risk-obsessed accountants, they do not present an existential threat to British pensioners or to our large employers. Unless , that is, we decide to force feed them with cash that would otherwise – “pay pensions!!!”

For these dividends are generally not used to line the pockets of Philip Green and the Fat Cats on their yachts, they are used to pay pensions to the pensioners of defined benefit pension schemes. Decreasingly so, as the mania for de-risking has determined that the negative real yields of bonds are better placed to do that.

When you starve pension schemes of the oxygen created by the dividends from large employers , you find yourself where the Royal Mail Pension Scheme is today. That scheme, you will remember was bailed out by us taxpayers a couple of years back and – when members accepted a change in the shape of future pension accrual (FS to CARE for the teccies), the scheme went into “surplus” – even under the arcane mark to market accounting formula.

The Royal Mail trustees decided to “lock in the surplus” by reducing the equity exposure of the scheme to minimal levels. But instead of immunising members from nasty shocks, they’ve created an immediate disaster for those still in the scheme and working for Royal Mail. The cost of moving out of equities equates to an increase in required contributions from the Royal Mail to 50% of pensionable payroll!

The employer and unions are now engaged in discussions on how to keep the scheme open without ruining the competitiveness of the Royal Mail. It goes without saying that paying 50% of payroll into a pension does not make paying dividends to shareholders very easy!

So plugging deficits and moving pension schemes into de-risked assets, does not improve the prospects for future accrual. JLT clearly see this as a happy outcome

“We believe that next year’s accounts will show that the majority of FTSE 100 companies have ceased DB provision to all employees” .

their report states  “that paying pension deficits by withholding dividends would help to preserve shareholder value”.

Shareholder value from paying no dividends?

This bizarre concept is new to me. Most shares are valued by the future steam of profits. Plugging notional deficits with tomorrow’s dividends will reduce the value of ownership of a company’s equity and thus the value to the shareholder of holding the equity.

Take the companies quoted in JLT’s survey


These company’s shares are widely owned by the pension schemes of similar companies. The prospective loss of those dividends for a year would materially disadvantage those schemes, forcing them to seek returns in other areas. The impact would be less money for these firms to invest and less cover for their pension payments.

If the long-term aim of our pension schemes is to invest 100% in bonds and take no “notional” risk, then they are going the right way around it.

The FT concludes its report on JLT’s findings with a wry comment

The report noted that the average pension scheme asset allocation to bonds had increased from 59 per cent to 61 per cent, even as the price of these assets climbed to record highs.

Presumably it will be into bonds that the redirected deficit payments would be made. The price of these bonds is sky high because of the already massive excess of demand over supply. A further bond purchasing round might keep the great bond bull run alive for another year or so , but it is crazy to think that the run can last for ever. This chart shows just how extraordinary our current bond bull market is



The argument is that if bonds fall in value, then so do pension scheme liabilities and things will be alright. But that is to assume that JLT’s prediction comes true and we have no future pension accrual in our DB schemes. Actually a very large part of DB plans in the public sector remain open for accrual (much funded by equities).

The pension schemes that have decided to remain in productive assets (mainly equities), would be stymied by any loss of dividends. The consistency of equity dividend payments is one of the few things that pension trustees can rely on. Pulling the plug on dividends would be an act of vandalism, not just against future pension accrual but against shareholder value.

There is another way

The only way that shareholder value would be improved, were if equities were to be considered a short-term trading counter for market speculators. Shares are typically held for long-term investment reasons, no more so than when pension funds buy them.

By resisting the temptation to invest in bonds and “de-risk”, the best estimate returns of a pension scheme can take into account the long-term dividend flow and benefit from the equity risk premium. This is why FABI shows a more optimistic view of the future (Blue not Purple line)fabi-graph

“The other way”, involves taking a long-term view of pensions. It involves buying and holding real assets like equities and infrastructure and not marking those assets to market as if they were going to be sold tomorrow.

The “other way” is called investment, it is the opposite of speculation. Speculation is betting, betting on short-term events such as interest rate fluctuation.

We must stop valuing our pension schemes as if they were items of speculation. The accounting positions of our schemes (on which JLT’s numbers are based) are of little significance to the long-term business of paying pensions.

It is time that we took a longer-term view of our future (as Brexit demands). It is time that the political leadership of this country started demanding (as Richard Harrington is demanding) that pension investment drives economic growth to get us through the change to an independent Britain.

We must not cut dividends, we must invest in and hold real assets.

In summary, the accounting deficits that JLT are talking about are phoney. They are only real if we treat pension schemes as items of speculation. The rush to bonds is economically bad for this country, its pension schemes and the future accrual of member benefits. The call to cut dividends to allow more bonds to be bought by pensions is simply an accelerator to the death-spiral that mark to market accounting has created for funded DB schemes.

We must stop giving credence to these bad news stories. If we want Britain to become an economic Narnia (forever winter but never Christmas) then we will carry on with the program of pension de-risking that we have embarked upon. If we want some sunshine and a more productive and prosperous future, we have to embrace the equity risk premium as our long-term ally.



About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in accountants, actuaries, pensions and tagged , , , , , . Bookmark the permalink.

4 Responses to Plugging phoney deficits does no good!

  1. Gerry Flynn says:

    ” independent Britain.”, what is that may I ask, and don’t give me the UKIP hogwash about making our own laws and restoring “Sovereignty”.

  2. Gerry Flynn says:


  3. If only someone in authority like pension trustee boards will take note and act in this common sense Manet the day will be saved. Will they?

    History shows that market theory and the security, ney ‘safety’, of fixed interest bonds, now so deleriously overpriced, will rule the day until it becomes too late to capitalise on today’s value and sell bonds to invest, as you state- for the long term- in the marketplace.

    Pension funds are not only essential for pensioners they are the lifeblood of national and international commercial prosperity. Chile and Australia exemplify that statement and your reasoning.

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