There is a paradox besetting defined benefit pensions. The Pension Regulator’s proposed DB funding code insists schemes take risk off the table while the person TPR reports to , Guy Opperman is busy asking them to put it back on again.
The paradox is beautifully explored in this great talk from Con Keating, which asks why accounting standards have led to discount rates so low that DB schemes are always chasing their liabilities only to see deficits widen as real yields remain negative.
In this webinar, Keating examines the role of discount rates in IFRS19 (Employee Benefits) in the reporting of defined benefit pension schemes. He considers the fundamental properties of discount rates and uncertainty and goes on to demonstrate that the approach in the current standard produces liability values which are counterfactual to the true liabilities of a DB scheme.
Crucially, as a result of the decades-long declines in interest rates, the standard has and continues to overstate the magnitude of pension liabilities. Con Keating considers a range of alternate methods which are in use, e.g. those utilising the expected return on assets as the discount rate, and show that all of these rates are exogenous and produce counterfactual values for liabilities.
He finishes by proposing a new method, the contractual accrual rate (CAR), to evaluate pension liabilities. This rate is endogenous to the pension contract(s) and accurately reflects the accrued value of pension liabilities of the scheme’s sponsor employer.