Defined benefit (DB) scheme providers are being urged to rethink their approach after being burnt by poor market performance.
MLC Implemented Consulting has launched an advice guide for trustee boards and company management that looks at the extent of underfunding and provides solutions to the crisis.
The problem is that surpluses have disappeared and actuaries are suggesting it is time to restart or substantially increase contributions. Further complications come from new accounting regulations, aimed at improving transparency.
MLC suggests that Australian companies re-appraise their DB fund now in order to prevent suffering a similar fate to their overseas counterparts. In the US, Bethlehem Steel and US Airways have filed for Chapter 11 bankruptcy within the last 18 months citing their respective DB deficits as a key cause.
In the UK, Rolls Royce, British Airways and ICI all have market capitalisations that are now less than their DB funding shortfall.
DB solvency in Australia has not yet deteriorated to the levels reached in the US and UK, according to the Australian Prudential Regulation Authority (APRA).
MLC argues this is due to the existence of the Superannuation Guarantee, as well as to Australia having a lower proportion of DB schemes.
MLC says if a DB fund has a significant surplus, the company can afford to invest more aggressively than a fund with little or no surplus. It says contribution flexibility is a key lever the trustee and company can manipulate to manage fund solvency, teamed with investment strategy for the assets backing DB liabilities.
The greater a company’s flexibility to adjust contributions, the greater the freedom to seek higher long-term returns and contributions through a more aggressive strategic asset allocation, says MLC.
Investing in assets that perform differently to liabilities creates mismatch risk, causing volatility of solvency and contribution rates. This is particularly important, as solvency volatility will show up on the balance sheet and income statement following the expected introduction of the accounting principles contained in IAS19 in 2005.
MLC argues that the best match for DB liabilities, which are driven by salary inflation, are inflation-linked bonds. These are not perfectly aligned but invariably represent the closest and lowest risk match.
Inappropriate DB strategies are unlikely to be rescued by a prolonged bull market, warns MLC, as was the case for much of the industry in the 1980s and 1990s.
