UK - Corporate pension schemes underestimate their pension liabilities because they base calculations on questionable inflation and longevity assumptions, according to a report by Hymans Robertson.
The report - which analysed FTSE 350 companies' annual reports and the methodologies used to calculate liabilities in defined benefit schemes - measured both financial assumptions such as inflation, and demographic assumptions such as longevity. It found a significant divergence between the assumptions used to calculate liabilities and liabilities as eventually reported.
According to the report, 65% of companies used a retail price index (RPI) assumption that was lower than market-implied inflation of 3.6% - suggesting that many companies believe the market is overpricing inflation.
Typically, companies that had switched to the consumer price index (CPI) adopted an assumption 70 basis points lower than the RPI assumption. However, the CPI assumption ranged from 2.3—3.4%.
Describing inflation assumptions this year as "subjective", the report's authors pointed out that the absence of a liquid market in CPI made it impossible for companies to measure against market expectations when setting their assumptions. The range also reflected the shape of the inflation curve and schemes' relative maturity.
The study also found an 8% gap among pension funds' longevity calculations for members not yet retired, and 7% gap for members already retired - an aggregate 20% addition to liabilities, predicated on each additional year of life expectancy adding 3% to pension scheme liabilities.
The average pensioner life expectancy was 86.7 years for a man and 89.1 years for a woman, compared with 88.6 years for male, and 90.6 years for female, non-pensioners.
Yet the report also found significant convergence around benchmarks on issues such as discount rates and return on equities, with a central cluster of companies sharing assumptions on likely equity returns. According to the report, 70% of company anticipated equity returns of 7- 7.8%, although 23% of companies anticipated a return of above 8%.
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