John Ball, head of UK Pensions at Towers Watson, said: “A myth seems to have taken hold that pension schemes must value their liabilities by using an interest rate that starts with current gilt yields and adds a fixed margin. Many schemes instead start with the returns they expect to get on the assets they hold – which will vary with market conditions – and build in a prudence margin. Where the Government could help pension funds significantly would be to encourage the regulator to present this as an acceptable approach.
“The Exchequer will collect more corporation tax if any change results in companies making smaller payments to their pension schemes. It would be tempting to see this as an easy way to help balance the books but the Government should tread carefully, especially as there is already flexibility over how quickly employers pay off deficits. We hope the Government can be persuaded that changing the way the regulator goes about its business would be more sensible than turning the system upside down.
“Any adjustments to pension liabilities should be justified by beliefs about the future and not by looking in the rear view mirror to see what gilt yields used to be. Any smoothing approach could result in a less flexible and more rigidly prescribed regime which could have undesirable consequences when market conditions change. Employers whose liabilities might initially be reduced by smoothing could find that it makes things look worse if interest rates rise – a case of needing to be careful what you wish for.
“Sensibly, the Government does not appear to be considering smoothing liability values in isolation. Low interest rates on gilts and high market values for gilts are two sides of the same coin, so it would exaggerate the health of pension scheme funding to smooth liability values without simultaneously marking down the value of gilts held as assets.
“The regulator’s response makes it clear that it believes the responsibilities of trustees and companies remain unchanged for the time being. Uncertainty over key areas of the funding regime will however make it very difficult for those with early 2013 valuations to make decisions and we urge the DWP to complete its review as quickly as possible.
“Local government pension schemes are due to undergo fresh actuarial valuations in March. Although these are subject to different rules, another motivation for today’s announcement may be to hold councils’ pension deficits down and therefore reduce pressure on council tax.”
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