DB liability valuation changes could have significant impact

The announcement by the Chancellor in the autumn statement of consultation over how defined benefit (DB) liabilities are valued could lead to significant changes, according to fund manager Schroders.

Jonathan Smith of Schroders’ UK strategic solutions said that the autumn statement put forward two potentially significant changes for DB scheme valuations: “Firstly, the Department for Work and Pensions (DWP) will explore allowing companies to smooth their asset and liability values. The DWP will also consult on whether to instruct the Pensions Regulator (tPR) to consider the long-run affordability of deficit recovery plans for pension scheme sponsors.”

Smith said that if DB liabilities were measured by a smoothing process, rather than using market values, this could significantly improve funding levels by around 15% at a typical scheme. He added: “Whether any benefits would persist however is unclear. Unless yields rise fairly soon, the funding level benefits of smoothing liability values could unwind over time, with average interest rates trending downwards towards the current rate. This has led some to argue that the proposed changes represent little more than kicking the can further down the road.”

Secondly, Smith said that it shouldbe remembered that the actual cost of paying benefits will not change, and accounting and buyout liabilities will also be unaffected. He concluded: “As pension schemes begin to mature more rapidly, being able to fund actual benefit payments – rather than an estimated liability value – will become more and more important. This should temper any change in investment strategy.”