Defined Benefit Pension Plan Disaster

Accountancy Resources

Defined Benefit Pension Plan Disaster



Uncategorised Author: Admin

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To understand how best to develop a financial plan it helps to understand how some plans can go horribly wrong. We need to look no further than Defined Benefit Pension Plans (DBPP). Despite all the efforts of highly qualified actuaries and helpful government legislation, this multi-decade movement has turned out to be a train wreck.

DBPP were set up decades ago to provide pension benefits for company employees. However, it is now becoming increasingly apparent that in aggregate these plans are now in a huge deficit, and many have no chance of providing the funding for their employee’s pensions. For many this realization comes at the worst possible time – at or just before retirement, when they are least able to make up any deficit. So great has this problem become that corporations are now closing down these plans as fast as they can, in favour of providing defined contributions to their employees.

In consequence, although corporations are still providing some assistance, the whole question of pension provision and planning is effectively being passed back to the individual.

In effect, an entire savings industry with all those supposedly smart people, have suddenly thrown their hands up in horror and dumped the problem back with the hapless employee, who now has much less savings or pension than he had previously been led to believe.

What do you think they were doing all this time? How could they have got everything so wrong? What on earth does the employee do now? First of all, we need to understand what went wrong. Once we have learnt a few lessons we will be better able to understand how to make our own plans.

For a year of my life, as an actuarial trainee, it was my job to audit several of these plans and so I received first-hand experience of all the mechanics that went into examining and valuing them. I was never very comfortable with this process, and this is why I was happy to move on after a year. The audit seemed like it was a science, but after going through a few of them it soon become apparent to me that the whole process was entirely arbitrary. You get together the assets, liabilities, and contributions being paid into the pension plan and then make some assumptions, primarily about the rate at which you discount payments years into the future and also the investment returns you will receive.

Maybe this sounds reasonable, but the results are a bit like tapping the Hubble Telescope. Just a slight tap and you will find yourself in a different galaxy. Tweak your assumptions and a huge pension plan deficit miraculously becomes a healthy surplus. Which assumptions do you suppose the pension plan consultants decided to show to the company? Which assumptions do you suppose the company executives decided they wanted to use? Cumulatively, it is hardly a surprise that over a number of years of “rosy but reasonable” assumptions a shortfall or deficit tends to materialize.


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