Defined benefit pensions are delicate mechanisms designed for the purpose of providing pensions for generations of employees. Decisions taken in the last twenty years first to close DB schemes to new entrants, then to future accrual to current members and now to ongoing liabilities (through “de-risking”), so upsets that balance as to make the remaining pension arrangement ever more dangerous.
A wise friend wrote to me yesterday with his fear that the First Actuarial Best Estimates Index (FABI) is being misinterpreted (I suspect prompted by my recent blog).
I am concerned that the FABI index is being misinterpreted. It may surprise you and your colleagues to know that I have spent a lot of time defending the FABI. This is on the ground that it is NOT aiming to represent suitable scheme funding. It is much simpler than that – it assumed assets remain as now, and with investment returns on a best estimate basis.
But of course this assumption flies in the face of what is happening.
your colleagues understand that – it is not in any way prudent and ignores the fact that (rightly or wrongly) most schemes are de risking to some extent, which affects returns expected in future.
That does not make it wrong ( as a lot of other people argue – it is what it is).
But it is dangerous to use the headline that DB funds look healthy. Most are closed to new entrants and indeed now mostly closed to future accrual. The real world means they are de risking because sponsors want to limit their exposure and that must be taken into account in any real world assessment rather than a numerical exercise.
My friend has hit the central issue on the head. But we are used to looking at real world situations not as a regulator would (managing the actual risk), but as advisers. We are trying to manage the real world situation so they minimise the risks of pensions not being paid and of employers not being able to afford their pension promises.
So we are bolder and are beginning to ask the question
“how can we stop this attritional de risking which is forcing pension schemes to adopt asset allocations that drive them away from the (generally) healthy state in which we find them today?”
We would challenge the assumption that taking a scheme into a purely defensive position is good for anyone. If a team goes 1-0 up after ten minutes, it can try and defend its lead by parking the bus outside the goal but it really works. You are much more likely to lose 2-1 that way! If you carry playing the football that brought you the goal, you are likely to win with ease.
So when my colleagues think about the future of DB, they ask how DB can be integrated not isolated. How it might not wither and divide.
Here, as an example, is an idea that we are knocking about. It brings together three assumptions that we think are valid, from our experience of working with employers, trustees and members of DB plans.
- Members are very keen that they and their colleagues get good quality pensions from the work they do for their bosses.
- Trustees are frustrated by the attritional strategies imposed on them by employers and advisers, which are driving them into bond-based investment strategies.
- Employers like the idea of auto-enrolment and pensions for all, but are worried that the pension promises from lowly funded workplace pensions aren’t up to much.
If employers were able to offer a better pension for all staff, even if that pension was not guaranteed as the past promise had been, then workplace pensions might aspire to more than the translation of a defined contribution into a pot of cash from 55.
The freedom to offer a defined benefit without guarantees could be given to employers who offer such an arrangement under auto-enrolment (e.g. to all “workers”).
There would be a very small number of employers who would even consider such an idea, most of whom would have a DB plan in place. The re-opening of the plan, albeit without the same guarantees on future accrual, would actually improve the security of the existing benefits. The plan’s investment horizons would be extended, the asset allocation could be planned around growth and the benefits of adopting a “best estimates” approach to funding could be realised.
By making the plan open to all (even those who are not eligible jobholders) an employer moves from “parsimonious to a provider of pension plenty” (with the tax-advantages that go with deferred pay). Traditional allegations that DB schemes perpetuate the unfairness of executive pay, would have no play.
For staff, the idea of a workplace pension could be one of genuine interest. Staff might ask the question of the boss;
“what kind of workplace pension do you offer?”
But most importantly of all, employers could start to think again of pension spend not as an unwelcome obligation but as part of an integrated and enlightened reward strategy and staff could think of working for an employer as a means of getting a means to stop working (or at least easing the way out of work).
This is very close in thinking to the original ideas behind the defined ambition legislation which is fully enacted but for which we still await the detailed legislation. We have a green paper under construction. I hope it will be filled with positive ideas, like the one outlined above.
It is of course an answer to my friend’s implied criticism of our approach
any real world assessment rather than a numerical exercise
We want a real world where FABI is not a numerical exercise.