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The Actuary The magazine of the Institute & Faculty of Actuaries

Pensions publicity crisis

Many of you will have already read the anti-actuarial comments published recently in the Financial Times, such as the following:

  • Editorial – 31 January 2003
    … the actuarial profession should face the same harsh scrutiny that accountants have endured in the period following Enron’s collapse. Actuarial advice about long-term asset values and pension fund liabilities in the 20-year bull market of the 1980s and 1990s, often accompanied by bewildering mathematical complexity, failed to pass simple reality checks.…

    Worse, actuaries are subject to the same potential conflicts of interest that caused auditors such grief. To maintain a client with a large and expensive pension fund, an actuary has an incentive to provide advice that suits the paymaster. A temptation to base advice on optimistic assumptions for assets and liabilities is always present. Actuaries have a lot of explaining to do.

  • BT accused of understating problems at pension fund– 14 February 2003
    … analysts estimated [BT’s” deficit could be as high as £5bn to £6bn if calculated on current market values under the controversial FRS17 accounting standard… Peter Tompkins, of the Institute of Actuaries, said BT was using an ‘antiquated’ valuation system in assessing the health of its pension fund.

  • Actuarial antiquarians out of touch with risk… – 17 February 2003 (by John Plender)
    The actuarial profession is in total disarray on the rather important issue of how to value a pension fund.… This low-key profession is in the same self-destructive mode as the accountancy profession was in the late 1960s before the introduction of accounting standards. Not only are different firms of actuaries applying different valuation techniques at defined benefit pension schemes but even within firms, individual partners vary in their approaches. The antiquarian ones are using a methodology that is both flawed and at odds with economic reality.

    What makes this so damaging is the underlying conflict of interest. Operating within the short-term horizons of the capital markets, corporate executives have been only too happy to go for the lower contribution rate regardless of risk, especially when the risk was still concealed from shareholders by opaque accounting. Actuaries were only too happy to give them what they wanted.…

    The profession should get a grip on itself, I hear you say. Unfortunately, it cannot because some of its most senior members are still wholeheartedly committed to antiquarian moonshine.

  • BT actuaries caught in a parallel world (letter) – 18 February 2003
    Do BT Group and its actuaries inhabit a parallel world in which the FTSE is still at 6,000? … unfortunately my faith in [the actuarial” profession is still recovering from the severe knock it took over Equitable Life.

Volcanic controversy

It is hard to escape the judgement that these comments are the visible eruption of a volcanic controversy which has been rumbling in the underground caverns of pensions practice for years. We wrote last year of a similar BT pension fund controversy, which we scored as a draw between the economists and analysts at Goldman Sachs and the actuaries at Watson Wyatt.

At the risk of vast oversimplification, the underlying question is whether it is appropriate to apply mean-reverting macroeconomic perspective to equity market parameters. While it is easy to demonstrate randomness and freedom from arbitrage in the short term, the long-term perspective is not necessarily the same.

The profession’s only response to date (at time of going to press) was a letter from the presidents (17 February) reminding readers that the valuation method used by BT was one of several legitimate options under SSAP24 and that criticism of it as ‘antiquated’ was misguided.

Is this enough? How is the profession to overcome these criticisms on methodology and conflicts of interest? Which is better – to seek a ‘right’ answer to the determination of valuation positions and funding rates, or to create a mechanism such as an actuarial standards board to achieve consistent but ‘artificial’ answers? How important is it that volatility of funding rates may impair employers’ commitment to the social objective of decent standards of living in retirement?

As always, The Actuary wants to hear from readers – what were your thoughts when reading Mr Plender? How should the profession best respond?