The valuation game
On 20 July 1367, the English king Edward III granted the 27-year old poet Geoffrey Chaucer a pension of £13 per year (worth about £10,000 today). At this time, twenty years after the Black Death, retirement and death were synonymous, and 'pension' simply meant 'annual salary for life'. But Chaucer prospered in the service of the king. In 1374, the king granted him a pitcher of wine daily, and in 1377 this was converted into a second pension of £13, along with a further £6 per year from his patron John of Gaunt.
However, by 1388, a change in the balance of power at the court changed Chaucer's life of medieval prosperity overnight. The Treasury stopped paying his pension, and Chaucer was forced to sell on his pension rights in return for a lump sum, to avoid starvation. In 1393, after Chaucer wrote a humorous poem for the court, the new king Richard II awarded him a new pension of £20 a year.
Unfortunately, by this time, Chaucer was heavily in debt, forcing him to beg the Treasury for loans using the pension as collateral. In 1398, the king not only offered Chaucer protection from creditors, but granted the poet a cask of wine yearly to help him survive - only to be deposed soon afterwards. Fortunately, in October 1399, the next king, Henry IV, added a new pension of £26 annually to the existing one.
Chaucer seemed secure at last, and promptly signed the lease on a house in Westminster. But on 25 October the following year, having completed his masterpiece, The Canterbury Tales, Chaucer died.
Six hundred years later, pensioners typically enjoy more of their retirement than Chaucer did. But uncertainty in pension valuation has not disappeared along with the plague. Take the members of UK occupational schemes with bankrupt sponsors who won an important High Court victory against the government in February.
It is not yet clear what kind of settlement these claimants will obtain from the government - for example, whether it will be worth more or less than what members of insolvent schemes now get from the Pension Protection Fund. But the peaks and troughs in their expectations over the past few years would have been familiar to the author of The Canterbury Tales.
In Chaucer's day, questions of valuation hinged upon what kind of annuity was worth a pitcher of wine a day. Nowadays, as life expectancy at retirement rockets upwards, the all-important question concerns the discount rate used to value pension payments that lie far in the future. Should the rate be market-consistent or not?
The UK Treasury has just bitten this particular bullet on UK public sector pensions, and added hundreds of billions to Britain's national liabilities as a result. Meanwhile, the Swiss seem to be resisting to the last any attempt to value occupational pensions realistically.
The medieval Treasury that reneged on Chaucer's pension and forced him to sell the rights at what was presumably a fire-sale price could have used a higher, non-market-consistent discount rate to reflect its ability to cut pension payments. By revealing the true price of a cast-iron guarantee, today's Treasury is doing something subtler.
Showing the true cost highlights the generosity of public sector pay promises, in contrast to pensions in the private sector. If the public purse is placed under stress, cutting those public sector pensions could become politically easier in the future. As Chaucer put it, "But every thyng which schyneth as the gold, nis nat gold, as that I have herd it told."
The week on Risk.net, March 10-16 2018Receive this by email