How To Value A Db Pension For Asset Allocation Purposes?

[justthisbloke]

I don't like having too many eggs in too few baskets so I'm turning my mind to asset allocation. The first problem is to value the assets I have; most problematic being a DB pension.

If (hypothetically) I have a DB pension that promises to pay £20k pa in today's money in 20 years time, what would that be "worth" as a capital sum now? A sum that I think I should treat as a sort of bond for allocation calculations (I think). Assume that I'm no longer paying in and that the £20k rises with inflation (actually, it's more complicated than that as, IIRC, some of the "sum" is capped to 5% rises and some to something less.

Many thanks for any thoughts on this.

[ARIMA]

I don't like having too many eggs in too few baskets so I'm turning my mind to asset allocation. The first problem is to value the assets I have; most problematic being a DB pension.

If (hypothetically) I have a DB pension that promises to pay £20k pa in today's money in 20 years time, what would that be "worth" as a capital sum now? A sum that I think I should treat as a sort of bond for allocation calculations (I think). Assume that I'm no longer paying in and that the £20k rises with inflation (actually, it's more complicated than that as, IIRC, some of the "sum" is capped to 5% rises and some to something less.

Many thanks for any thoughts on this.

You'll need to look at you exact T&Cs etc (eg spouse benefits) but simplistically you should divide the guaranteed pension amount by the current equivalent annuity rate. Say for your brand of spouse and inflation protection that was 4% then roughly speaking your £20k pa would be worth 25x20 = £500k. As it is deferred for 20 years it's obviously worth a bit less than if it was in payment, but as I'm sure you are planning on being alive I would just ignore that.

Unlikely you would have inflation caps without inflation floors and by chance the cost of a zero floor roughly offsets the cost of a 5% cap at current prices.

In terms of risk you are mostly exposed to the creditworthiness of the pension providing, either directly if the scheme is underfunded and indirectly if it is well funded. There is some degree of backstop from the PPF as well - you can just google that.

It's a nice problem to have, but the amount you should worry about it depends on how well funded the scheme is (which can of course change over time) and the size of the parent company versus the scheme.

[justthisbloke]

Thanks, that's useful - broadly matches with my take on it. I think I'd worked it out similarly but then discounted it a bit for the time aspect.

I'd mentally pegged the value as being around £300k and am beginning to incorporate that into asset allocation - counting it as a bond. Which means I don't really need any much else in the way of bond-like investments.

[ARIMA]

Thanks, that's useful - broadly matches with my take on it. I think I'd worked it out similarly but then discounted it a bit for the time aspect.

I'd mentally pegged the value as being around £300k and am beginning to incorporate that into asset allocation - counting it as a bond. Which means I don't really need any much else in the way of bond-like investments.

Yes.. a secured bond from one issuer (got to keep an eye on the collateral) with a partial government guarantee. Interesting way of looking at things, the asset allocation approach - makes sense though.