How do they work out "Pension black holes"?

majorwally

Just been on the news that the Steel workers have a Pension black hole of £500M

I was once told that this "pension black hole" doesn't really exist as it would mean if all people in the scheme took their pension right now, which of course they aren't going to do.

Is this true, if not, how do they find the "£500m" figure when the workers and the government both pay into the scheme?

Also, if the scheme has been running for say 50 years, what happened to the contributions made for the first 30 years?
Surely, no one claimed for the first 30 years so a massive contributions pot must have built up wouldn't it?

AnotherJoe

majorwally wrote: »

Just been on the news that the Steel workers have a Pension black hole of £500M

I was once told that this "pension black hole" doesn't really exist as it would mean if all people in the scheme took their pension right now, which of course they aren't going to do.

Is this true, if not, how do they find the "£500m" figure when the workers and the government both pay into the scheme?

Also, if the scheme has been running for say 50 years, what happened to the contributions made for the first 30 years?
Surely, no one claimed for the first 30 years so a massive contributions pot must have built up wouldn't it?

Depends on your definitions. Lets say a "massive" contributions pot did build up but the pensions liability is "really massive" or "hugely massive". Then there's a problem. Your mistake, if I may be so bold, is to assume that these companies tracked what was going on and prudently changed contribution levels and pension entitlements to match,and that they werent caught out by changinge conomic events. lets say they figured in a 7% annual growth in the pension fund and now its 2%. A bit like some folk did with their mortgage endowments not being on track to pay back enough and getting caught out. You'd think a company might be better managed but you'd be wrong in many cases.

For example you'll find that what happened to many companies is that at some point they took a look at their "massive" pot and said "hey look thats really massive we dont need to pay into that anymore we can spend that money on extra bonuses to the board, or shareholders, or we can buy some new airplanes with it". (ever heard the term "pension holiday"?)

And then they didnt look again for a while and got used to spending that money on other stuff until someone said "oh s**** we have a problem, there's a pensions black hole"

This is what BA or its precursors did in the 90's or so. Now, BA is sometimes referred to as "a pension fund that happens to own an airline"

kidmugsy

The "pensions holidays" were largely imposed on firms by Nigel Lawson in the 80s when he announced that the Inland Revenue would treat continued employer contributions to schemes that already had surpluses as being the equivalent of tax avoidance.

The "black holes" are in large part because the schemes' liabilities have been amplified by the very low returns on bonds - in other words by the low prevailing interest rates.

Finst

At least every three years, the pension scheme has to perform what is known as a funding valuation. The scheme's actuary estimates all of the future expected payments out of the fund, and then calculates the amount of money needed today that (together with expected future investment returns) is needed to meet those payments. That estimate is then compared to the pot of money the pension scheme has built up by investing the contributions.

So if there is £600m in the pension scheme, but the future payments are estimated to cost £1,000m, then there is a "black hole" of £400m.

The "black hole" is an estimate of the extra money that will be needed in the future. The size of it is uncertain as it depends on a whole load of assumptions (investment returns, how long people will live, future inflation, which all have an impact on how much it will truly cost). Think of it as an educated guess.

Linton

I am not an accountant so can only give you a flavour......

As of right now a DB pension scheme has assets ( investments and cash) which can all be valued. It also has liabilities - those pensions which have already been earned and will need to be paid in the future. For example an employee may now have 10 years service and so be due 10/80ths of her current salary as pension in 15 years time. To check whether the scheme's assets will meet its liabilities one has to assume an investment return and work out for each liability how much money you need in assets now. So to be able to pay a £100 pension payment in 30 years time with an investment return of 3% you need about £37 now. Add all the £37's up assuming life expectancy and you get a current value of the liabilities.

The difference between the current liabilities and the current assets is the deficit (in tabloid speak "black hole") or surplus. As you can see there are some highly significant assumptions involved in determining liabilities which will be controlled by accounting standards. A large deficit number doesnt of itself mean things are bad. Conversely having a large surplus doesnt necessarily ensure that the employer can safely reduce their pension contribution and use the money for other purposes - a mistake made in the 1990s.

ischofie1

Someone correct me if I'm wrong but I think the black hole is often based on what value an external insurer will want for taking over the liabilities of a scheme.
IE If a fund is XXX amount and an insurer wants XXX amount + 30%, then the fund is considered under funded by 30%.
This I believe leads to funds being reported to be under funded by more than they really are as the insurer will have built in a profit margin & safety factor yet most schemes will never sell out to an insurer.

kidmugsy

ischofie1 wrote: »

Someone correct me if I'm wrong but I think the black hole is often based on what value an external insurer will want for taking over the liabilities of a scheme.

That's one of the two ways that a scheme can be valued. The other - which generally looks much less bad - is based on treating the scheme as an ongoing entity.

System

Finst wrote: »

So if there is £600m in the pension scheme, but the future payments are estimated to cost £1,000m, then there is a "black hole" of £400m.

.

But if there IS £600m in the scheme, it will be invested to cover the FUTURE payments. So surely you are not comparing figures at the same point in time?

The relevant figure surely is what the current £600m WILL be worth at the moment in the future when it has to fund the £1,000m ?

sandsy

Clifford_Pope wrote: »

But if there IS £600m in the scheme, it will be invested to cover the FUTURE payments. So surely you are not comparing figures at the same point in time?

The relevant figure surely is what the current £600m WILL be worth at the moment in the future when it has to fund the £1,000m ?

The liability is an estimate of the amount of money needed NOW to cover future payouts. So it the liability is estimated at £1000m but the assets only have a value of £600m, there is a rather large shortfall now.

kidmugsy

Clifford_Pope wrote: »

But if there IS £600m in the scheme, it will be invested to cover the FUTURE payments. So surely you are not comparing figures at the same point in time?

The relevant figure surely is what the current £600m WILL be worth at the moment in the future when it has to fund the £1,000m ?

What is compared is (i) the value of the assets, and (ii) the present value of the future liabilities.

Have a look around this forum; it's been explained in more detail recently by me and by others.

System

kidmugsy wrote: »

What is compared is (i) the value of the assets, and (ii) the present value of the future liabilities.
.

I see that, of course. It's just that the sentence I quoted didn't say "present value", just future liabilities.