The Actuaries


Way back in 1998 Barry Riley (now an honorary Fellow of the Institute of Actuaries) wrote two far sighted pieces on the Actuarial Profession, "Flexible actuarial valuations have encouraged UK funds to maintain very high exposures to equities" & "Deaf ears are turned to the pensions prophets".

The "pensions prophets" were Jon Exley, Shyam Mehta and Andrew Smith who had presented their paper "The Financial Theory of Defined Benefit Pension Schemes" to the Institute of Actuaries in April 1997. The November 2001 overview is a good place to start. Barry Riley had already written "A reality check for British pension funds" in 1997, as the paper was published.

Now 15 years after its publication, it is hard to overstate the paper's importance for the UK pensions' debate. It was a wake-up call to the Actuarial Profession by three actuaries who applied the insights of financial economics to actuarial theory and practice, pointing out that in the real world, with investors buying-and-selling, assets & liabilities are priced against the market.

They warned that if the Actuarial Profession did not start using market based values for pension assets and liabilities it was in danger of getting left behind, which, indeed, has happened, to a greater or lesser extent.

Some of the ears turned to the pensions prophets were not deaf and the market-based approach gained increasing support from other actuaries, including Tim Gordon, who presented the "The price of actuarial values" to the Staple Inn Actuarial Society in February 1999. This put the financial economics' argument in a way actuaries were more likely to understand. "Radical actuaries" are now no longer the exception and what was once considered radical is now commonplace. An Institute of Actuaries Press Release "Equities versus bonds" in June 2002 shows how far the Actuarial Profession has come.

The late John Shuttleworth of PwC also writes from a market perspective. His "Letter to the Profession" in The Actuary (April 2002), "Pension fund investment" (October 2001), "Predicting the future" (July 2002) and "Everyone shares the blame for pensions problems" (FT April 2003) are all excellent.

The impact of Exley, Mehta and Smith on Boots was huge - when I was sent a copy in Autumn 1997 I knew immediately it was one of the most profound things I had read for many years. It fitted in with Boots' whole approach to financial management and I wrote "Young Guns" in support in March 2001. Barry Riley also saw the influence of Exley, Mehta and Smith on Boots' decision. "Boots finds a safe prescription".

The market based approach to pensions is based on original work by US financial economists in the late 1970s and early 1980s, including Fischer Black, Bill Sharpe, Irwin Tepper and Jack Treynor. The seminal article by Fisher Black, & The tax consequences of long-run pension policy in 1980 was picked up again in a UK March 2003 article "Pension shortfalls need Black magic".

However, US actuaries have tended to be less influenced by financial economics than their UK cousins, partly due to the rules-focused approach encouraged by the 1973 ERISA legislation. There are some US actuaries thinking along market lines. Jeremy Gold's paper "Accounting/ Actuarial Bias Enables Equity Investment by Defined Benefit Pension Plans" was published in May 2000, but only found its way to the UK a year later with comments from Barry Riley in the context of the Myners' Report.

Jeremy Gold and Larry Bader also produced in July 2002 "Reinventing Pension Actuarial Science" discussing the "ossification" of US pensions thinking caused by ERISA. See also Larry Bader's May 2003 article in The Financial Analyst's Journal.

The US Actuarial Profession held a symposium on "The Great Controversy: Current Pension Actuarial Practice in Light of Financial Economics", with papers from several UK actuaries, including Cliff Speed, Jon Palin and me.

Over the last couple of years UK actuaries have come in for huge public scrutiny. The Actuarial Profession is now seen to have a crucial role both in pension fund asset allocation and investment & growth in the real economy and as guardians of security for pension scheme members. The conflicts of interest between duties to Trustees & members, on the one hand, and to the sponsoring company, on the other, have also been recognised, which the Actuarial Profession has not, so far, addressed.

Barry Riley outlines problems facing the actuaries in "Failing to make financial sense of the future" (December 2000) and "Hard times loom for actuaries" (July 2002).

Much of the comment on valuation of pension fund liabilities and fund solvency has been highly sceptical, particularly the way in which actuarial valuations "smooth" the impact of market movements and tend to understate pension liabilities. A lot of this scepticism centres on the BT Group pension fund, the largest in the UK, one of the few pension schemes to have its own website. (

In July 2002 BT suggested its pension deficit was only £1.6bn, the same as at December 2001, despite the FTSE all-share falling by a quarter and 2/3 of its fund being in equities.

UBS put BT's deficit at £6bn at July 29 2002 and in a characteristically lucid note said that BT were sticking to £1.6bn because " their actuaries have effectively told them that the market is wrong and that equities have not really fallen in value".

The ability of actuaries to defy gravity was dissected by Philip Coggan in "Actuarial tempers running high" and John Plender in "Spare a thought for the Old Lady's pension: Actuaries to the (virtual) rescue" and "Bubble, bubble default trouble".

A truce was called over BT's pension deficit until February 2003 when it reported its third quarter earnings and said its actuarial valuation, to be finalised in May 2003, was likely to show a deficit of only £1.8 to £2.3bn. An FT article on Valentine's Day "BT accused of understating problems at pension fund" quoted a prominent actuary that BT used an "antiquated" valuation system. Martin Dickson in the FT commented that "Given the size of the potential problem, and the difficulty of making investment judgments in a fog, we could do with more openness from BT and others in its position."

This provoked a stream of FT claims and counterclaims about BT in particular and actuaries in general. The Presidents of the Faculty and Institute of Actuaries defended BT "BT's valuation method is a proper one" and the Senior Partner of Watson Wyatt and BT's actuary said there was "Irony in accusations of optimism". However, a senior Hewitt Bacon & Woodrow actuary pulled no punches in saying that actuaries were "A divided profession". Amongst all these actuaries the amateur view was put simply as "BT's actuaries caught in a parallel world".

John Plender weighed in with "Actuarial antiquarians out of touch with risk: But still sold on moonshine" and "Moonshine (cont)", pointing out that the actuaries valuation methods artificially biased pension scheme investment towards risky equity assets.

The discussion about actuaries also extended to the pages of the Daily Express, with the headlines "Men at war over pensions" and "Actuaries' fury over £93bn hole? . Less contentiously, the Times suggested "Actuaries tackle the problem of longevity".

See Jon Exley's 2001 paper "Pension funds and the UK economy", which could be sub-titled "What the Myners' Review should have said, but didn't". It argues that the asset/ liability mismatch in UK pension funds involves a real economic cost, acting as a drag on UK economy.

Andrew Smith also shows statistically in 1998 "Salary-related cash flows" that equities are not a match for salary related pension liabilities, undermining part of the traditional justification for holding equities. When the Institute of Actuaries admitted to the ASB that this was indeed the case (contrary to previous arguments) it came as a great surprise.

In developing their earlier thinking in consultation with the Actuarial Profession the ASB had assumed that the matching assets for salary related liabilities were equities.

Finally, a plug for the Actuarial Profession's website
and that of The Actuary Magazine, which contains some very good articles -See "Why move to bonds?", "The trouble with FRS17" and "FRS17 - An equity analyst's perspective"

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