• Procrustination

If that word does not exist, it should; it is far more appropriate than the current euphemism “consolidation”. This past week we saw the publication of JLT’s paper: How do we get out of this pensions ‘black hole’, and we expect, from its many previews, the final report of the PLSA’s DB taskforce to have as its central theme: “consolidation”.

This week, at the TUC conference, I heard lines describing trustees’ duties such as:

“to ensure that all of their members’ benefits are paid out in years to come”

and to ask the question:

“does an action reduce the level of risk to members’ benefits.”

It even extended to a particular and popular narrative:

“Companies are trying to reduce their covenant obligations”

A more accurate narrative would be that companies are trying to counter the arbitrary and capricious additional costs of the procrustean bed of regulation, embodied in current actuarial and accounting practice.

None of these descriptions is true or fair. The obligation of a trustee is to secure member benefits.

The amount of these benefits at a point in time is a matter of fact; it is derived from the contract with the employer sponsor and the time that has passed since the award. It emphatically does not involve consideration of any future events, other than benefit projections.

The idea that trustees should be concerned with the sponsor covenant, with respect to future developments which may or may not occur, is nonsensical. It is an article of faith handed down by the Pensions Regulator, presumably in pursuit of their objective:

“to reduce the risk of situations arising which may lead to compensation being payable from the Pension Protection Fund (PPF)”.

This objective conflicts with sound scheme oversight and management.

One of the most perverse consequences is that this penalises disproportionately precisely those employers who offer their employees the most generous pension terms.

The true objective – securing member benefits – is achieved by holding an amount of assets sufficient to discharge the accumulated value of awards made to date. This is not some present value of projected benefits, however derived.

Depending upon the terms of award, and developments in financial markets, on sponsor solvency or other liquidation, it may or may not be sufficient for a member to buy equivalent benefits in some market.

Given the efficiencies of the collective risk sharing and pooling mechanisms of DB schemes, it is to be expected that, on average, it would prove insufficient. In this, the DB scheme member is in the same position as would be a DC scheme member who owns the (secured) public debt of the sponsor company. This does not present a problem for the PPF, though it would require revision of the manner in which they set levies. In any event, they have been setting levies far above those economically or financially justified since inception.

Many courts have opined that DB benefits are deferred pay; they are occupational arrangements. From this it is immediately apparent that the full value of benefits may only be expected to be achieved after the complete passage of time. One of the principal problems with the regulatory, actuarial and accounting standards is that, by viewing the pension scheme and fund as a stand-alone entity which must be funded to provide all benefits, it weakens this linkage.

“Consolidation”, better procrustination, takes this to its ultimate limit.

The specific conclusions and recommendations contained in the JLT report warrant some discussion. The British Steel case is cited as evidence of a deficit-based need for change, when in fact the scheme is now in surplus on a technical provisions basis and if the alteration of the basis of indexation (from RPI to CPI) is agreed by members, will be able to continue as a stand-alone entity.

This has not required any change in regulation. The Brexit decision is also cited, though I worry when I see the specific ‘advantages’: no application of European Directives, or appeal to the European Court of Justice.

The paper notes the disparity in costs between DB and DC; a correct concern.

This week I listened to a very, very long litany of problems with DC arrangements – as savings, they really cannot properly be called pensions. Elsewhere than pensions, such a profusion would usually be taken as strong evidence of a wrong and inappropriate model. It has of course severed the link to the sponsor employer; these are no longer either deferred pay or properly, occupational pension schemes.

Given the relative efficiency of DB versus DC, one of the most remarkable features of recent times has been that the valuations of DB are so overblown that DC may be more attractive for many members, and a transfer flood ensues.

The Regulator is complicit here. Their reported stance, which might be summarised as:

if you believe the employer covenant is strong, then you think stayers will have all benefits paid in full, so you shouldn’t be reducing the benefits of leavers,

is more than a Catch 22; it calls upon trustees go beyond their duty and to consider future events, with the implicit threat that if trustees argue for reductions, they risk requiring the sponsor to contribute more to the scheme.

The proper course of action for a trustee is to consider only the current level of scheme funding and pay no more, proportionately, than that, and even this may exceed the member’s properly calculated entitlement.

The JLT paper recommends relaxing transfer rules and allowing early access to the tax-free lump sum, which flies in the face of pensions as deferred pay. Why not give them access immediately on award?

The paper also suggests that funding should be to the level of PPF benefits and that this would generate a huge immediate gain. It certainly would not have this effect if the basis of calculation was that specified by the PPF for the s179 valuation, which is now calculated on a buy-out basis. The most recent scheme funding statistics report that the median Technical Provision/s179 valuation ratio is 101.6%.

The paper does suggest the use of higher discount rates, such as those based upon the expected return on portfolio assets, but it does so from a bizarre standpoint:

“… imagine pension funds no longer needed to invest in gilts…”.

We do not need to imagine this; it is the status quo. The use of gilts as investments by pension funds stems from their use in determining the discount rates used for the valuation of liabilities; it then becomes a tautological, misconstrued but central part of the so-called de-risking of schemes.

Although the use of unfunded and insured schemes is touched upon in this paper, it lacks the insight and vision to recognise the full potential of these approaches, which incidentally could include massive savings in tax concession costs.

Funding is at best an incomplete solution to DB pension provision; it is certainly extremely and wastefully expensive. The problem of sponsor insolvency is best addressed by insurance, individually and collectively.

An appendix proposes new tests around “going-concern” status. It does not seem to understand that if the Directors believe the company is no longer a going concern, they must liquidate it. It is appalling to find leveraged driven investment being supported; this can only undermine the security of scheme members. It is pure speculation.

There is a case study; (no practitioner report is complete without such a study).

Case studies are a very powerful device for the development of a particular narrative. Academics, of course, would dismiss them as mere anecdotes. This particular study traces the movement of a scheme over time to full buy-out and scheme wind-up.

I cannot help but wonder if legal scholars might not consider this case study to be a confession of complicity in the assisted suicide, or murder, of a scheme.

While we might criticise the report for its highly selective use of evidence in support of its case, the far greater problem is that the authors appear to believe that the situation has the moment of a law of nature, that there is an inevitable “gravitational pull”. This is not the case; this is an entirely man-made mess.

The report may also be criticised for confusing fact and opinion; a fine case in point is the use of opinions from the Intergenerational Foundation and Institute for Fiscal Studies in support of their view of intergenerational unfairness.

I will accept that the nonsense reported as pension ‘deficits’ does influence investor behaviour and the prices of quoted company shares, but this is not an effect of the ‘deficit’; it is a rational response to the diversion of corporate time and resources into entirely non-productive uses, that arise from these ‘deficit’ figures.

We should be thankful that the report does not subject us to any arguments for the commingling of scheme administration, assets and benefits, but that is surely coming in the PLSA report and the DWP’s Green Paper on DB.