6. ACTUARIAL ASSUMPTIONS
6.1 In order to derive the present value
of benefits already accrued and benefits accruing over the next
three years (and hence the Actuarial Liability and Standard Contribution
Rate), it is necessary to make a number of assumptions. Future
expenditure on benefits needs to be compared with future income
from contributions and from the returns likely to be achieved
by investing those contributions and the assets held in the fund.
In assessing the expenditure on benefits, it is necessary to allow
for the probability of the occurrence of each event giving rise
to benefit and the length of time that the pension benefits will
continue to be paid once the member has left the scheme. Assumptions
therefore have to be made in relation to both financial aspects
of the pension scheme and the demographic aspects of the scheme
membership.
Demographic Assumptions
6.2 Active Members. For the valuation,
assumptions are needed on such factors as rates of mortality,
retirement and withdrawal from Parliament. Where possible, the
past experience of the scheme is used as a guide. In considering
the appropriateness of the assumptions for an actuarial valuation,
it is important to have regard to the likely long-term scenario,
taking account of the likely incidence of General Elections. I
have taken account of the turnover of membership at the General
Election on 5 May 2005 but have assumed that there will not be
another General Election in the period before the next actuarial
valuation is due, in April 2008. The most important assumptions
made are described below.
6.3 Pensioner Mortality. Significant
improvements in mortality rates have been observed across a range
of ages and sectors of the UK population. The expectation amongst
demographic experts is that improvements are likely to continue
in future years, although there is a large degree of uncertainty
about the future rate of improvement. I have allowed for a greater
longevity of PCPF members than was assumed for the 2002 valuation.
This is illustrated by the following figures for the assumed life
expectancy of a member at age 65.
Assumed Life Expectancy
Remaining life expectancy for a 65-year-old (years)
|
| Males | Females
|
| Assumed at the 2002 Valuation | 17.5
| 21.4 |
| Assumed at the 2005 Valuation | 19.5
| 22.6 |
| | |
In addition, for current MPs, who will not in most cases
reach age 65 until several years in the future, I have incorporated
an allowance for further improvements in longevity, which increases
the assumed life expectancy by up to one year more. Details of
the mortality tables adopted are given at Appendix E.
6.4 Career Patterns I have taken account of the
turnover of MPs at the May 2005 General Election, and have revised
the assumptions about the future career patterns of MPs, in light
of experience at the last several elections. MPs are now assumed
to leave and retire at higher ages on average than was assumed
at the last valuation. The table below shows the expected average
age on leaving Parliament that has been assumed in this valuation
for members who were elected or re-elected at the May 2005 General
Election.
Assumed Age at Leaving Parliament
| Age at valuation date | Average expected age of leaving Parliament
(having been elected or re-elected in 2005)
|
| 40 | 55 |
| 50 | 62 |
| 60 | 65 |
| |
Financial Assumptions
6.5 Value of Liabilities. For the valuation, the
liabilities, which comprise the future outgo on benefits and expenses,
need to be compared with the income from future contributions
and from investments. In order to compare the value of these items,
they have been capitalised as at the valuation date, by discounting
the future streams of income and outgo with allowance for interest
and the probability of payment. As the income and outgo will occur
over a very long period in the future (as much as sixty years
or more in the case of current contributing members) the assumptions
which have to be made as to interest and inflation rates necessarily
relate to this very long period in the future.
6.6 Increases in pension benefits are awarded under the
Pensions (Increase) Acts and are therefore linked to increases
in the Retail Prices Index. (The scheme's governing regulations
contain no provision for further discretionary increases to benefits
and so none have been allowed for in this assessment.) Benefits
awarded at retirement are related to the level of members' salaries
at that time, and contributions are defined as a percentage of
salaries. In general, high rates of salary increases and price
increases are associated with high investment yields, and the
differences between investment yields and inflation are more important
in the valuation than their absolute values. The investment returns
actually achieved by the scheme since the last valuation have
been below the level of return that was assumed at the 2002 valuation.
However, undue weight should not be given to short-term factors.
6.7 For this valuation, I have assumed that, in the long
term, investment yields will exceed general increases in earnings
by 2% a year, and will exceed price increases by 3.5% a year.
These assumptions have been retained from the 2002 valuation.
The cost of pension increases on the part of the scheme pension
corresponding to the statutory Guaranteed Minimum Pension is either
not borne by the scheme or is borne only to a limited extent of
up to 3% a year. To value this part of the pension, a gross investment
yield needs to be assumed, and a long term rate of 6.5% a year
has been adopted. This is a reduction from the assumption of 8%
a year which was adopted for the previous valuation, reflecting
the continuation of low nominal rates of interest and inflation;
however this assumption has little effect on the valuation result.
6.8 The financial assumptions are summarised in the table
below.
Financial Assumptions
| Gross rate of return | 6.5%
|
| Real rate of return, net of earnings increases
| 2.0% |
| Real rate of return, net of price/pension increases
| 3.5% |
| |
6.9 Value of Assets. It is essential in valuing
the scheme's assets that there is consistency with the valuation
of the scheme's liabilities. Since the liabilities have been valued
by discounting expected benefits at long-term average rates of
return, it is appropriate that the value of assets is assessed
by discounting the future stream of income expected to be produced
by the assets on assumptions which are consistent with those used
for valuing the liabilities.
6.10 Value of Equity Investments. The value of
the equity assets has been determined by discounting the expected
dividend income. The dividend income has been discounted at 6.5%
a year, assuming that the current level of dividend income will
increase at 3.4% a year (0.5% per year in real terms). These assumptions
imply a long-term dividend yield of 3.0% a year, which compares
with the dividend yield on the FT-Actuaries All Share index at
31 March 2005 of 3.09%.
6.11 Value of Non-Equity Investments. The UK Government
(gilt) investments of the scheme have been valued using an approach
similar to that used for the valuation of liabilities. The future
income and redemption proceeds from the fixed-interest stocks
held at the valuation date have been discounted at 6.5% a year.
The proceeds from the index-linked stocks have been discounted
at 3.5% a year net of price inflation. Property assets have been
valued consistently with the equity assets. Cash deposits and
other net current assets have been taken at their face value.
6.12 In the market conditions applicable at the valuation
date, this approach to the valuation of assets results in the
assets being brought into account at close to market value. The
market value at 31 March 2005, from the scheme accounts, was £280.8
million (excluding members' Additional Voluntary Contribution
funds of £2.4 million), whereas the discounted actuarial
value is £278.6 million.
6.13 Expenses. Administration expenses incurred
by the scheme during the three-year inter-valuation period were
around £1.9 million, excluding investment management costs
and a one-off statutory withdrawal fee payable to the Public Trustee.
A capital reserve of £8.2 million is set aside to meet expenses
expected to arise in future. The costs of investment management
are implicitly taken into account in determining the rate of return
on investments assumed for this valuation.
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