Supplementary evidence from John Ralfe Consulting LDI0065

Previously submitted LDI0020, LDI0051, LDI0059

Work and Pensions Committee Inquiry into DB pensions/ LDI

Could I comment on PIRC’s written evidence, which you may like to raise with Tim Bush on Wednesday. I should say that PIRC’s evidence is not entirely straightforward to follow, and I may have misunderstood it.

https://committees.parliament.uk/writtenevidence/116165/html/

1. PIRC discusses long-standing accounting for DB pension liabilities, which it argues is fundamentally wrong, and has led to perverse consequences, including “national security issues”. It concludes, under the heading of “National security”  that:

“There should be a Parliamentary review of national security implications of international accounting standards dealing with matters of significant economic activity.”

2. To support its case that pension accounting is wrong, in Section 3 “Abracadabra – now you see it now you don’t”, PIRC writes:

“There is a clear anomaly between the rates insurers use and the rates pension funds use to discount pension obligations”.

UK companies report DB pension liabilities under IAS19 – the international standard – or FRS102 – the UK standard. Both require DB pension liabilities to be discounted at a high quality AA corporate bond rate.

PIRC suggests the discount rate used by insurance companies when they buy DB pensions from a corporate is higher than a AA bond rate, and :

“the favourable accounting standard magics a large part of what IAS19 gives as a “liability” – and hence a “funding deficit” - away.”

3. It is not clear if PIRC is recommending that companies should use the same discount rate as insurance companies, which would, if PIRC is right, reduce their DB pension liabilities, and deficits.

Whatever conclusion PIRC may want to draw, I question whether its claim that insurance companies use a higher discount rate for DB liabilities,  “magically” shrinking pension liabilities in a pension buyout.

I have looked at the “valuation rate of interest” used by Pension Insurance Corporation and Rothesay – the UK’s two largest buyout firms - to discount their pension liabilities, and compared this with the IAS19 discount rate with three companies with a December year end.

In all cases the IAS19 company rate is higher than the insurance company “valuation rate of interest”, which means the value of pension liabilities is higher for the insurer than the company.

This seems to undermine PIRC’s argument that somehow the AA bond rate overstates the value of DB pension liabilities, leading, in its view, to perverse consequences.

I would be grateful if you would add this note to my written evidence to the Committee. Please feel free to ask any questions.

Appendix  DB pension discount rates

January 2023