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The Actuary The magazine of the Institute & Faculty of Actuaries
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FRS17

In the latest issue of The Actuary you carry several letters from actuaries complaining about the impact of FRS17 and suggesting a return to the inclusion of expected future excess returns on equities in pension scheme valuations.

Leaving aside the question of whether investing in equities really is the equivalent of a free lunch, or an actuarial philosopher’s stone, can we draw a parallel with life funds?

In essence, a life fund with guaranteed liabilities can invest in equities if – and only if – it can be seen to be able satisfy its guaranteed liabilities; that is, if it has extra funds which would act as a buffer against adverse experience which might otherwise reduce policyholders’ guaranteed benefits. Life offices should not gamble on future equity returns, using the funds that are meant to be supporting members’ guaranteed benefits.

Now substitute ‘pension fund’, ‘members’ immediate discontinuance entitlements’, and ‘members’ for ‘life fund’, ‘policyholders’ guaranteed benefits’, and ‘policyholders’ in the paragraph above. The result suggests that equity investment is not a sound approach for the many underfunded pension schemes today.

Even if we do not regard discontinuance benefits as ‘guaranteed’, then normal actuarial matching principles surely suggest that underfunded schemes should be investing in bonds (or their equivalent), which would be a closer fit to the discontinuance liabilities than equities. The argument that an underfunded scheme can invest in equities because it may not need to discontinue rings rather hollow in the face of the plight of the increasing number of members whose underfunded schemes have indeed discontinued.