How should trustees and employers negotiate valuations?

Jonathan Reynolds: I have been on the corporate side, and if the actuary comes to me and says, ‘Look, your trustees are doing this all wrong, they need to be using this method; this reduces your technical provisions by x, our deficit is now much lower and you can pay less’, what finance director is not going to listen to that argument?

The right debate should be: what is a sustainable, correct contribution that the employer can afford to pay into the scheme?

Jonathan Reynolds, Capital Cranfield Trustees

If that is the motivation, I am unconvinced that we are having the right debate. The right debate should be: what is a sustainable, correct contribution that the employer can afford to pay into the scheme? I have also done some work with a corporate on genuine affordability, and there is a valid argument. There are times when you can genuinely see that an employer needs to invest in its business, and that we could reasonably take a lower contribution because that genuinely is covenant enhancing, as long as that is not pie in the sky – it has to have a proper business plan and be well thought out behind it.

Andrew Cheeseman: You have only painted one side, though. Over the past 10 years, for example, is it not the fact that motivation may have been to pay less? We are now hitting a point where the motivation is saying, ‘Are you sure that I should be paying more?’

It is a fair challenge to say, ‘Are you sure your basis is correct?’ That is where it is coming from at the moment; not that financial directors are trying to reduce costs, they are just trying to maintain their costs.

There has to be a point where it is detrimental to the business to keep going in this direction, otherwise all you have is a pension fund and no business.

Reynolds: What you have said is that ultimately you are having the debate with the employer about the level of contributions. This is what it all comes down to; that is the real debate that you end up with at the end of the process.

What I want to absolutely try and avoid is having a pre-argument over the technical provisions before I get to the real nub of it, which is how much money we are going to get.

Cheeseman: Yes, and unfortunately the regulator does not necessarily impart it the way you would like it, because the first thing the regulator says to you is, ‘Could you please give me a copy of your proposed funding report that you intend to present to the employer?’

I do not do valuations that way; I get something done on the old basis, I look at it, I then have a discussion with my actuary, he tells me that there are other methods and we might be getting a bit out of kilter, maybe we ought to alter the gilts plus a half basis to gilts plus one, and we have that debate based on sound economic reasoning.

Then I sit down with the employer and we discuss what the employer can afford. I might get the covenant review done just to make sure that I am not being hoodwinked etc, and then we come up with a proposed draft. It is a team approach to what is reasonable. Unfortunately, that is not the way that the regulator thinks we do it.

Andrew Young: I think it is one way it works when done well.

Paul McGlone: I have a client who is 12 months into their 15-month valuation deadline, and they have asked me about valuation methods. That is the last thing they need. The valuation methods are not going to change the high-level answers and decisions; the company has got a certain level of affordability, there is a big deficit that needs paying, and if you want to go into a three-month long discussion about the valuation method, it is really not going to help you. There are circumstances in which I think it will, but there are so many circumstances in which it will not.

We are now hitting a point where the motivation is saying, ‘Are you sure that I should be paying more?’ 

Andrew Cheeseman, Pan Trustees

Leslie Scrine: If we were to adopt gilts plus prudent instead of gilts plus one, I take it that means that if we are in the middle of a bear market, we are actually expecting a rebound in returns, and therefore the conversation with the finance director is, if you like, a bit easier at those times.

Then, conversely, if we are at the top of a bull market, the conversation is starting with gilts plus quite a thin margin, so we are seeking more contributions at a time when the company is more likely to be able to afford them.

McGlone: If you base your assumed return on a best estimate from the market less a margin, with the intention that margin leaves you with a similar level of prudence overall, that discount rate does not move as quickly as gilt yields move, and therefore you see a smoother progression of your liabilities.

However, you do still see that over the past seven years when yields fell by 3 per cent, best estimates also fell by 3 per cent, so liabilities went up by 50 per cent anyway, it is just that they have gone up more smoothly than had you followed gilts plus a margin.

So when you follow it through all the way, you can find that a different method has certain benefits, but it does not get away from the fact that if you are in a low-yield, low-return environment, you need more money in your pension plan.

Young: It is just that you want to avoid unnecessary volatility along the way. Or arbitrary volatility that is misinterpreted and leads to demands for more money, or indeed less, when it is not really necessary or appropriate.

David Weeks: Demands for more money – schemes are looking at different ways to do that. One way that seems to be gaining ground a bit is linking it to dividend payments to shareholders. Should the contribution deficit rise in line with that?

The other one which seems to cause problems, particularly with companies with overseas parents, is what sort of guarantee have you got and will the overseas parent give any guarantee at all.

Young: I would trust them to look at all forms of security they can get. The one about dividends, I think, is included in the framework of the regulator’s code; that you should pay the trustees fairly in terms of all the relevant stakeholders of the company.

Cheeseman: You do have to remember that the purpose of a company is to provide profits for the shareholders. There is no point in having a company if it does not produce profits.

Young: It has to pay its debts, too.