Mark Wood discusses the consultation into the long-term affordability of deficit recovery plans for sponsors

The new year starts, as has so often been the case, with a consultation. The 2013 edition will garner opinion on the appropriate discount rate for the calculation of pension deficits for the purposes of agreeing the amount of cash the sponsor should be required to transfer across into the pension scheme. In the Chancellor’s Autumn Statement, in addition to stimulating individuals’ short term payments into defined contribution schemes, by reducing the annual allowance for tax relief and the cap for total contributions, there is the promise of the possibility of a helping hand. The proposed consultation offers, with the suggestion that just maybe, deficits should ignore markets and instead use the past as a guide to the future by ‘smoothing’ the valuation of assets and liabilities, by reference to rates which are no longer available. The precise purpose of the consultation is to look at the arguments for and against giving The Pensions Regulator a new statutory objective concerned with the long term affordability of deficit recovery plans to sponsoring employers.

The consultation is about the amount of cash which is required of companies and of course has no impact on FRS17 valuations. Thus, notwithstanding the limitations of the accounting standard in providing a guide to the actual financial burden represented by the pensions’ scheme, the impact on corporate valuations is likely to be minimal. Moreover the Chancellor is inviting consideration of a means to enable corporates to save cash at a time when companies hold historically high cash balances. Set these puzzles aside though. Whatever the outcome of the consultation, the trustees, backed up by the regulator, will decide. The need to take account of affordability is already implicit in the regulator’s objectives. Where a funding plan has been agreed only a sudden and material change in a company’s ability to pay would cause a revision to the funding plan. Arguably in these circumstances a sponsor can already appeal. So in the vast majority of cases should the Chancellor’s thinking be accepted, trustees will simply shorten the timescale over which the recalculated deficit is made up. This is the only prudent course which trustees can adopt. If during the foreshortened recovery period markets have celebrated a mean reversion all well and good. If on the other hand Andrew Sentence’s ‘new norm’ has prevailed, nothing is lost.

That said the proposal is fundamentally flawed. The only rational rate to use to assess the value of assets and the current quantum of the future liabilities is the return which the assets in the scheme are actually achieving. The consultation’s offer of smoothing is unlikely to prompt well advised trustees to switch from gilts and bonds to equities. While this was the case when a similar change was enacted in Denmark and Holland, the reaction is not logical. The appearance of a deficit reduction is just as likely to be seen as an opportunity not to keep risk ‘on’ but to take risk ‘off’. This will particularly be the case if the new rules were to result in a surplus.

The initial pre-Christmas response to this idea came from the profession and professional commentators. The reaction was comprehensively negative. Perhaps Lombard was the most out spoken; ‘When assets are marked to market and liabilities are valued according to expediency, logic has left the building’.

Written by Mark Wood, non-executive chairman at JLT

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