“Deficit – What deficit?” asks First Actuarial as the FAB Index climbs for the third month in a row
First Actuarial’s Best estimate (FAB) Index improved for the third month in a row, showing a month-end surplus of £308bn and a funding ratio of 125% across the 6,000 UK defined benefit schemes.
In the same month, the deficit on the PPF 7800 index also improved from £186.2bn to £180.1bn.
Meanwhile, industry indexes that focus on accounting deficits actually worsened over the same period, leading First Actuarial’s Rob Hammond, to ask:
“Deficit – what deficit? The UK’s 6,000 DB schemes are in aggregate running a healthy best estimate surplus. When commenting on pension funding, we’d encourage those giving answers to make everyone aware of what question they are answering!”
Hammond added:
“The FAB Index answers this question: What is the deficit (or surplus) of the UK’s 6,000 defined benefit pension schemes calculated using best estimate assumptions?
“As there is no prudence in the assumptions used, it is not a suitable basis for funding purposes, but provides trustees and employers with a useful measurement to consider along with the buyout position, when deciding how to fund a pension scheme. Knowing both of these measurements helps trustees and employers to see explicitly how much prudence is being allowed for in funding assumptions.
“Deficits calculated for PPF and accounting purposes answer completely different questions. Much of the media’s attention in recent months has focused on soaring accounting deficits, which have been largely caused by low bond yields, and don’t necessarily translate into increasing funding deficits.”
The technical bit…
Over the month to 31 July 2017, the FAB Index improved, with the surplus in the UK’s 6,000 defined benefit (DB) pension schemes increasing from £301bn to £308bn.
The deficit on the PPF 7800 index also improved over July from £186.2bn to £180.1bn.
These are the underlying numbers used to calculate the FAB Index.
| FAB Index over the last 3 months | Assets | Liabilities | Surplus | Funding Ratio | ‘Breakeven’ (real) investment return |
| 31 July 2017 | £1,525bn | £1,217bn | £308bn | 125% | -0.7% pa |
| 30 June 2017 | £1,515bn | £1,214bn | £301bn | 125% | -0.6% pa |
| 31 May 2017 | £1,534bn | £1,239bn | £295bn | 124% | -0.8% pa |
The overall investment return required for the UK’s 6,000 DB pension schemes to be 100% funded on a best estimate basis – the so called ‘breakeven’ (real) investment return – has remained at around minus 0.7% pa. That means the schemes need an overall actual (nominal) return of 2.9% pa for the assets to meet the liabilities.
The assumptions underlying the FAB Index are shown below:
| Assumptions | Expected future inflation (RPI) | Expected future inflation (CPI) | Weighted-average investment return |
| 31 July 2017 | 3.6% pa | 2.6% pa | 4.1% pa |
| 30 June 2017 | 3.6% pa | 2.6% pa | 4.2% pa |
| 31 May 2017 | 3.6% pa | 2.6% pa | 3.9% pa |
Henry, if the best estimate shows a healthy surplus whilst the “prudent” accounting methods show a large deficit, then these companies are actually sitting on a hidden pot of gold.
If only they could see that and follow a course of action to realise that surplus over the long term!
Adrian
I’m sure the good folk at First Actuarial would agree that there are more productive uses for the pension scheme’s assets than to buy more corporate and government debt! If DB schemes had the courage of our actuarial convictions, then we’d be seeing a lot more money invested in real assets making a real contribution to this country’s productivity. Who knows, a productive Britain might be able to afford decent pension contributions for all!
So what does USS accounts show using this basis?
USS have to account for their pension liabilities using a discount rate based on bond yields. This shows a massive deficit. The issue is whether this deficit is real or not. If the accounts showed the deficit based on a discount rate, one – for instance – based on the imputed return on the assets in which it is actually invested – it would show something different.