In the Hitchhiker’s Guide to the Universe series, the character Zaphod Beeblebrox wore a nifty pair of “Joo Janta 200 Super-Chromatic Peril Sensitive Sunglasses”, which had been specially designed to help people develop a relaxed attitude to danger. At the first hint of trouble they turned totally black, preventing the wearer from seeing anything that might alarm.
The UK pension industry now seems to want to adopt the accounting equivalent. The National Association of Pension Funds has called for an overhaul of accounting rules that govern the disclosure of company retirement liabilities, arguing that these are intellectually flawed and partly to blame for the widespread closure of schemes.
The move is hugely significant, not only for the UK but around the globe. The UK led the big revolution in pension fund accounting over the past 10 years to value assets and liabilities of a scheme at a snapshot of current market values.
The shift under the controversial FRS 17 accounting standard away from a system of fudging valuations by “smoothing” out market swings led to a fundamental change in the relationship between companies and their pension funds.
Amid the volatile stock market conditions of the noughties, it brought home to companies the real risks they were taking with so-called defined benefit pension funds — schemes where the retirement income of members is based on a fraction of annual salary that increases with length of service.
The knock-on effects were far-reaching, triggering the closure of hundreds of so-called defined benefit pension schemes as companies sought to stem their losses. It also led to changes in asset allocation, with funds slashing exposure to equities to invest in bonds that matched their liabilities.
The closure of schemes might have been have been painful for their members but in many cases it was inevitable given the scale of risk taken by companies. For some companies, the size of their pension fund dwarfed their market capitalisation. It was once reputed that the pension fund of British Airways, at one of the low points of the carrier on the stock market, could have bought every share in the airline and still stayed within its guidelines of not putting 10 per cent of its funds into any single investment.
And the shift in asset allocation towards bonds sharply reduced the risk that pension funds fall short of assets to meet their promises to members.
But now the NAPF wants to turn back the tide in an extraordinary reversal.
“Current accounting standards have been very damaging to defined benefit provision, leading many companies to close their schemes. Pension funds are long term institutions but today’s accounting standards fail to reflect this,” said Lindsay Tomlinson, chairman of the NAPF and a veteran fund management executive at Barclays Global Investors, now consumed by BlackRock.
This is a feeble excuse. Pension funds might be long-term institutions but long-term is not necessarily less risky. Just look at equities which have basically done nothing for a decade after all their swings. Any fund that assumed a positive long-term return from equities at the height of the dotcom boom would now be in deep problems, as many funds are.
Mr Tomlinson also offered another justification, by arguing the underlying assumption of valuing assets and liabilities to market is that markets are efficient in setting prices.
“What I say is that we all know the efficient market hypothesis is a flawed hypothesis and it is being talked about in the banking world, too,” he said.
Well that is slightly curious coming from an executive who has spent a career in the index-tracking fund management industry. This is business is based on the idea that active fund management is flawed as markets are largely efficient and it is difficult to beat them after taking into account costs.
And if markets are inefficient that only highlights the risks of assuming some kind of long-term returns to minimise an estimate of current liabilities.
What kind of fudge does the NAPF think should be employed? Or should investors in companies and members of pension fund just don the Zaphod Beeblebrox sunglasses and ignore the risks?
Related reading:
Lindsay Tomlinson, chairman of the National Association of Pension Funds, on accounting standards FT video
The pensions crisis FT interactive graphic
