On the go: Aon is urging sponsors and trustees of UK defined benefit schemes to do more than “just kick the tyres on historic valuation approaches” and check their actuarial valuation choice is right for their scheme.
UK pension schemes share a common challenge; deciding how much money they need in order to deliver the promised benefits, factoring in both the uncertain nature of the cash flows and the very long-term nature of the promises made to members. This is the purpose of an actuarial valuation, which sponsors and trustees are required to carry out by law at least every three years.
The long-term nature of DB promises means the approach used by pension funds to discount future cash flows to come up with a ‘present value’ of how much cash is needed to pay benefits is of critical importance.
Many commentators have debated whether discount rates should be set relative to expected returns on the pension scheme assets, with reference to the yield on low-risk assets such as gilts or even whether focusing on discounted present values is appropriate at all.
Yet most schemes have continued to decide to use gilt-based approaches for their valuation, according to Aon research. The prices of gilts provide a good baseline for understanding both the costs of settling liabilities and running a low-risk portfolio in the future.
Equally there are a number of schemes who do not fit this mould. For example, the scheme may be open to new entrants, or will be run-on over the medium term in a self-sufficient fashion, avoiding paying over a premium to an insurer or consolidator. Different valuation approaches are ultimately just measurement tools.
A new white paper, ‘Choosing the right actuarial valuation approach’, examines the complex options facing UK pension schemes and the implications of their chosen method of valuation.
Commenting on the report, Jay Harvey, partner at Aon, said: “For something so fundamental to a pension scheme, valuations are a famously complicated area, with many factors which need to be considered before a single number is calculated. Among others, these will include the strength of the scheme sponsor, the long-term objectives of the scheme, the resulting investment strategy – and whether there is an appetite to use one of the more technically sophisticated approaches.
“For all schemes, different valuation approaches are ultimately just measurement tools. But selecting the right one is essential – and not letting the tool drive the decisions is even more important. With this paper we hope those involved with schemes can make certain they do more than just kick the tyres on historic valuation approaches and instead ensure that the valuation tool they use is the right one for their scheme’s future needs.”
