by Calum Cooper, Head of Trustee DB at Hymans Robertson
A client of mine recently gave me some positive feedback (it happens) about our approach to valuations which got me thinking. What is it that doesn't work with the traditional valuation approach?
In valuations of old, the discount rate is a bit of a conversational magnet. All avenues lead to the discount rate. And whilst it sports some attractive features - familiar, seemingly straightforward, focuses the attention - it masks significant failings:
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Dealing with depression. Gilt yields look depressed for many well trailed reasons including QE. To what extent do you believe that your assets will deliver 'gilts plus' given current levels of interest rates? (0.25% p.a. in the short term).
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It's abstract. What bearing does it have on what really matters? It seems to me that many trustees and corporates would rather work out how to increase the probability of delivering promised benefits and build in more capacity to absorb shocks. A discount rate led valuation doesn't help here.
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Leads to story telling. Subjective disagreement on discount rate tends to flow from a desire to achieve specific (often presentational) outcomes. I've seen this put a strain on relationships between sponsors, trustees, advisors as well as increasing time and effort (cost).
So what have we been doing that led to this positive feedback?
A while back we realised that Scheme Actuaries focussing on the discount rate and cash outcome was too one dimensional - for all the reasons above. In addition, it also limited the investment advisor who had less leeway to enhance the investment strategy. So we re-jigged our valuation approach. First we included a second dimension - investment strategies - to be considered alongside different cash outcomes. More options opened up. Finally, we weaved in a third dimension - the context of the business supporting the scheme. This lead to increasingly measured risk taking and alignment of interests.
So, a valuation without a discount rate, looking across these three dimensions, improves outcomes. It leads to less time and cost spent discussing assumptions that have no bearing on member outcomes, funding plans that have a better chance of paying out members' benefits and meaningful contingency plans if things do not work out.
Our approach is called 3D Funding. We've done valuations this way for a while. Hopefully this approach will play its part in increasing the quality and security of peoples' lives in retirement. A heady aim, but worth aspiring to.
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