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Opinion: Blackhole three times deeper than previously thought

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James Fraser, head of LEK Consulting’s financial services practice, warned in the Financial Times on 9 January that the pension deficit facing the largest companies in the UK might be three times bigger than the sum they have estimated it to be using FRS 17.


It has been generally agreed that the pension deficit calculated using FRS 17 is about £50 billion. Fraser suggests it could be as high as £150 billion. His logic is simple. He says that FRS 17 is too optimistic about the rates of return that companies can achieve because there are too few securities of the quality that it assumes available to meet the demand from pension funds. In addition, he says companies are not taking sufficient account of peoples increasing longevity when performing their calculations.

He can make his suggestion about longevity with impunity. As he rightly points out, despite the acres of reporting dedicated to pension funds there is no requirement to report mortality assumptions used in calculating pension obligations included in financial reports. So he may be right. And he may not be. No one knows, and that is worrying in itself.

And he has a clear logic for his claim that investment strategies also mean that deficits are understated. If a company wants to close its fund it is now required to pay for “buy out” insurance to cover the risk that there will be a pension shortfall. This is frequently costing a great deal more than the pension deficits declared under FRS 17 rules, and Fraser suggests that this is because there is a simple shortage of capacity in the financial markets to underwrite the scale of risk that exists within pension funds. This is because appropriate AA securities are simply not available.

This risk is not apparent, he says, because many funds do not invest for the long term even though their liabilities might last for more than 30 years. Fraser believes pension trustees are seeking to stabilise their short-term deficits by investing in reasonably secure equities and so prevent balance sheet volatility for their companies rather than investing to meet their obligations.

There has already been comment in the FT suggesting that any forecast of pension deficits is bound to be seriously wrong. It has to be accepted that the calculations will always be subject to a wide degree of error.

But James Fraser and the insurance underwriters to whom he refers are making a point that the writer of this article has made for a long time, which is that to presume that pensions can be provided on the basis of investment in the shares issued by companies that represent no more than 30% of UK economic activity may well be optimistic. It may also represent a serious distortion in the market for capital funds.

If Fraser’s comments draw attention to that fact whether his calculations are right or wrong will not matter because what he’s saying is that the big issue is not the amount of money in the funds, but the fact that the funds can’t be invested productively. This is the point that the Turner commission failed to address.

Richard Murphy is a freelancer for AccountingWEB

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Annie Hayes

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