The way pension deficits are calculated are either "unhelpful" or "broken", say professionals

Oliver Gill
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Royal Mail is negotiating with unions over the closure of its final salary pension scheme

The UK’s spiralling pension deficits are not being calculated appropriately, professionals have said while being left bamboozled about what methodology to use instead.

Deficits have edged back from all-time record highs last summer. But they remain a huge headache for some of the UK’s largest companies.

Royal Mail is facing industrial action by its 160,000-strong workforce after announcing plans to shut its final salary scheme. The closure plans came as the firm revealed the annual bill of servicing it had sky-rocketed to £1.3bn.

Other blue chip firms, such as BT and Tesco, are facing multi-billion pound shortfalls and testing negotiations with pension trustees this year.

Read more: Royal Mail retires pensions scheme: The what, why and how

But according to one of the world’s largest actuarial firms, research suggests the way in which schemes are calculated may no longer be appropriate.

More than half of respondents (56 per cent) to a poll by Aon Hewitt said the popular “gilts plus” method for valuing pension schemes is “not helpful” in the current lower-for-longer interest rate environment. A further eight per cent said the method was “broken and should not be used”.

The gilts plus method references the yield from a UK government bond and adds a spread. It is the most common method, used in around 90 per cent of cases.

While research suggested gilts plus was not popular, professionals have been left scratching their heads as to what should replace it.

“It’s very very easy to throw mud at something and say ‘Oh, that is rubbish’,” said Aon Hewitt retirement and investment partner Paul McGlone.

But a lot of the mud thrown at the gilts plus method really doesn't stick because all the other methods have the same sort of characteristics.

Read more: Good news for pensions? We aren't going to live as long as we thought...

McGlone added that expected returns have fallen across all asset classes. This means whichever calculation method is used, the cost of paying benefits to pensioners will have risen in recent years.

Last week the Pensions Regulator said scheme trustees should be less “prescriptive” in valuation methodologies. Where the gilt plus methodology worked for some pension plans, it may not for others.

A more flexible approach was supported by McGlone. He urged trustees not to “slavishly follow” one method but consider which was most appropriate given the needs of both the company and pension scheme members.

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