The poll of over 800 pensions professionals was conducted around the UK during Aon Hewitt’s annual pension conference series. It followed a session which considered all the main alternatives and examined the pros and cons of each. The polling allowed delegates to select from one of four responses:
Question: Is the ‘gilts plus’ method still appropriate?
Yes, it is completely appropriate - liabilities are bond-like and it's appropriate to use a bond-like way of valuing them 27%
It still has a place, but it is not helpful in the current environment 56%
No, it is broken and shouldn't be used 8%
Don't know 9%
The survey was conducted on the back of debate within the pension industry around valuation methods. This has largely been driven by falling gilt yields and hence rapidly increasing liability values. The responses highlight that, though the method has its challenges, it is far from being permanently broken in the eyes of the industry. Part of the reason for this is that most of the viable alternatives also show liability values going up by similar amounts.
Paul McGlone, partner and scheme actuary at Aon Hewitt, said: “The first concern about the ‘gilts plus’ method is that it places a value on the liabilities that is too high. But when you examine that closely it's not clear that the criticism stands up to scrutiny. If we accept that we are in a low yield and low return environment, then the amount of money needed to pay pensions goes up, and contributions need to do more of the work. Denying that and assuming that returns will be higher doesn't solve the problem – it just hides it.”
Since the start of 2010, yields have fallen by about 3%, increasing the value placed on a typical pension scheme's liabilities by around 50% compared with what they would otherwise have been. However, over the same period, expected returns on other asset classes have also fallen by similar amounts.
Paul McGlone continued: "The second concern about the method is that it encourages investment in gilts and bonds at a time when they are expensive by historical standards. There is some truth in that; measuring funding by reference to gilts will result in gilt-like movements in liability values, which can then only be hedged by gilt-like investments. But schemes should be investing and measuring based on their long-term objectives. If those long-term objectives are not to hold gilts then measuring progress with a strict ‘gilts plus’ method is not going to be helpful."
Jay Harvey, partner at Aon Hewitt, said: “It may be that if the ‘gilts plus’ method is to remain in use, more can be made of its flexibility. One of the key flexibilities is the ability to vary the size of the ‘plus.’ Although scheme’s trustees and advisers become accustomed to the assumptions used, best practice is to review the size of the ‘plus’ at each valuation and, where justified, adjust it based on economic conditions. The Pensions Regulator also encourages schemes to do this. Although they like to see consistency in approach, they want schemes to take a robust and well-informed approach to valuations."
Jay Harvey continued: "It is also worth stressing that the Pensions Regulator is not wedded to ‘gilts plus’ as a method, and the recent annual funding statement reiterates this position. If a scheme has no intention of using gilts in the long-term and therefore wants to use a method which generates discount rates through some other means, then there is nothing in legislation or regulatory practice to prevent that. As long as the approach is robust and well-informed, then there normally won't be a problem.”
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