All entries for Sunday 22 February 2015

Misleading pensions story in the Telegraph

Yesterday's Daily Telegraph headlines an article entitled Final Salary Pension? Your retirement income is at risk.

It provides figures provided by the Pensions Protection Fund for all private final salary defined benefit pension schemes showing assets of £1,200 billion and liabilities of £1,500 billion giving a shortfall of £300 billion.

(The actual figures for February 2015 are £1,273.8 billion of assets and £1,641.2 billion of liabilities.)

For a number of reasons this calculation should be treated with a big pinch of salt.

First, these figures are capital sums and bear only an indirect, theoretical relation to the actual pensions that require to be paid in the future and the money available to pay them. As a matter of elementary economics, pensions cannot be stored up to be drawn down later when we retire. Pensions are received as income when they are required and paid out of expenditure by pension schemes. So the assets/liabilities comparison is problematic.

Any variation in asset values has little bearing on the ability of the pension scheme to meet the actual payments of money to pensioners required. In the same way if your house goes up in value that does not automatically mean you have more income - you have to sell it or mortgage it etc before you can convert it to an income - there are extra stages to go through which are not necessarily simple. The link between a pension scheme's asset prices and the pensions it can afford to pay is not direct.

Second, they are calculated on different bases and their comparison is misleading. Asset prices are valued at market prices on a particular day. Penson liabilities are a theoretical amount that would have to be lent to the government assuming the continuation of the current recessionary conditions and historically very low interest rates for ever into the future, and also making the most pessimistically prudent assumptions about trends in life expectancy, future inflation, wage growth and so on. Thus some might think it prudent to assume salaries will grow rapidly (suggesting a belief in economic growth) while interest rates will continue at currently recessionary levels. Some might question the wisdom of assuming two contradictory things at the same time. This is central to the USS valuation.

Third, these figures are both very approximate and should come with a wide margin of error attached. It is puzzling that it is not considered appropriate for the Pension Protection Fund to provide us with such error bounds. It can't be hard to do. The deficit figure being the difference between two such large magnitudes therefore has a much larger margin of error. (This is elementary statistics.)

Fourth, the figures are very volatile. The assets are volatile because their prices go up and down with the stock market. Stock market prices reflect all sorts of influences and not just the rational expectations of investors: political, psychological, institutional factors are just as important. Herd behaviour, speculation, the effects of financial derivatives and Rumsfeldian unknown unknowns cause asset prices to be far more volatile than the income those assets might yield.

The liabilities are even worse. Small changes in discount rates exert a strong effect and cause huge volatility. And remember that the actual pensions that are paid to retired people are defined by the rules of the scheme. They are not affected at all by changes to government bond rates. So any changes for example due to Quantitative Easing are completely irrelevant - so why base the calculation on them? The calculation only makes sense under very particular and not very realistic assumptions about the economy.

The figures for the deficit are thus so volatile as to be misleading.

Fifth, the figure for the deficit seems so large as to be frightening. Some commentators are fond of saying that public sector pensions liabilities (such as for the TPS) represents additional unfunded public debt and therefore the true level of debt is much larger than we suppose. This is a wrong argument because government pensions like the rest of public sector salaries are part of current spending out of taxation. This exaggeration of the scale of debt is really scaremongering intended to frighten people into accepting detrimental changes to their pension rights. Pensions are actually deferred pay.

Unfortunately this method has been enshrined in the rules and the legislation. That does not mean we should not question it. There are many instances of bad laws being enacted and subsequently changed.

Dennis Leech : 22 Feb 2015 03:51 |  Tags: Pensions;Uss;Tps |  Comments (0) |  Close comments |  Report a problem