Con Keating on integrated risk management-(@PensionPlayPen lunch).


If you attended the Pension PlayPen lunch on Monday March 6th, you may have wondered where I was- I was on a plane returning from India. I am told it was good fun and Con Keating called it the best discussion he’d had on DB in years. There were 14/15 present which argues for me staying away some more!

If you were there and you are not Con Keating, Tom Hibbard, Kevin Westbroom, Mark Scantlebury, Mike Lacey or Akash Rooprai or Barbara Weber, please drop me a line on or simply leave a comment. Thanks in particular to the tall man who arrived late, left early and sat in my seat – your comments about “tPR triumphalism post BHS”  have been well noted!

At the end of the meeting- Con promised to re-articulate his comments on integrated risk management- here they are!


Con Keating.

This note outlines the issues driving the apparent increases in the cost of private sector occupational DB financing. It abstracts from much, leaving many arguments and nuances uncovered and unstated. These increases have two distinct roots – the purpose of the pension scheme and fund, and the accounting techniques applied.

At the urging of the Regulator scheme trustees are encouraged to believe that their purpose is to pay the benefits promised by the sponsor employer, and to pay them regardless of the condition of the sponsor employer. Interestingly, though there are many exhortations to this effect, when it comes to describing trustee duties formally the regulator does not reference such an objective. Similarly, the DWP Green Paper states this objectiveas desirable but then refers only to the statutory scheme funding regulations, which are silent on this. This narrative is fictive not factive.

In fact, the duty of a trustee is to secure the benefits as they have accrued to a point in time. Capital markets instruments have long known such security arrangements. The amount of security required for a debt instrument is clear; it is the amount originally advanced plus any accrued but unpaid debt service as defined in the contract. It is emphatically not forward looking. It is performance of the promise to date. It is not future, possibly foregone, performance.

This means that many other Regulatory practices, such as the introduction of integrated risk management and consideration of the sponsor covenant by trustees are entirely unnecessary and redundant. They are pure real cost to the scheme. The only justification that the Regulator has for this is their statutory obligation to protect the PPF. While this objective is plausible, there is no reason why the PPF should need protecting. Pension indemnity arrangements exist in many countries and there are none where such protection is deemed necessary. The correct way to deal with any risk or moral hazard issues is by the pricing of cover – in other words through premiums and deductibles. The likelihood of sponsor insolvency, and the degree of funding determine this. It is interesting that in other jurisdictions, member benefits are not reduced and schemes may be entirely unfunded corporate book-reserve arrangements. This indemnity cover typically costs less than the management and administration expenses of an asset portfolio. The PPF should be privatised and opened to competition; the statutory duty of the Regulator in this regard removed.

Viewing the scheme as a standalone or self-sufficient entity is a major mistake. It amounts to creating a stand-alone insurance company and requires capitalisation at those levels raising the cost pf provision of the pensions. This is to the detriment of employees, whose earnings are depressed, and the detriment of other creditors in insolvency. Moreover, for the majority of schemes, it will create a problem of orphan assets after all pensions have been discharged. If this absolute and continuous security of the final benefits is desired, the correct form is not funding but pension indemnity insurance.

We have only recently seen the prospective introduction of true stand-alone schemes with BHS and British Steel. The PPF levy consultation in that regard is exploitative; these entities should be allowed to buy indemnity insurance from other commercial providers.

The purpose of the pension fund in this view point is twofold: to provide security of the promise as made and accrued to date, and to supplement, defray or defease the sponsor employer’s liability to pay pensions and maintain adequate security. The analysis absent from the Green Paper is the question of these pension payments (gross and net) in the context of the sponsor’s cash flow generation from ongoing operations.

In capital markets, it is customary for delinquencies with respect to security shortfalls to require “cure” or remedy within days or weeks; pensions need be no different, if the accrued amounts are calculated in the same manner.

In numerous other articles, we have introduced and explained the derivation of the contractual investment accrual rate of pension promise, which is fully determined by the contribution made at time of award and the projected benefits payable. It is only slowly changing with the experience of mortality and inflation, and new awards made in new terms. It is time consistent, which means that it will return the same value when used as a discount rate applied to projected benefits as when used as the investment accrual rate of the contribution made. This contrasts with the two methods permitted under scheme funding rules, which are both discount formulae. These implicitly and explicitly apply only to the assets within the fund. The contractual accrual rate is the cost of the employer and equivalently the return on investment of the contribution to the scheme member.

If the return on assets formulation were interpreted as this rate; the true and fair position would be reported, by virtue of its time consistency. A deficit using this rate should require cure, in just the same way and short time scale that a corporate debt security would.

Valuations using gilts or similar parameterisations of a discount rate are inappropriate for the pension liabilities of a sponsor; these liabilities already exist. The methods specified in scheme funding regulations are appropriate if we wish to evaluate the amount we would require to acquire these liabilities ab initio, at the time of valuation, for perhaps a transfer.

The section 75 debt is also problematic. Funding to buy-out levels is expensive and inequitable – to employees and creditors. It is questionable whether this debt, even though statutorily defined, would withstand a robust challenge by other creditors in a liquidation. The correct form for this issue is not to encourage excess funding, but to price the level of funding observed into the cost of indemnity cover.

Without indemnity cover, the pensioner would be secured as to the accrued level of the promise made by the sponsor. This may or may not be sufficient to buy equivalent benefits in the market place, and given the efficiencies of risk sharing and risk pooling within a DB scheme, this should be expected on average to be insufficient. However, it is the position of the market bond-holder and indeed DC holders of secured bonds; it is equitable.

With indemnity cover, the level of funding is a matter of commercial negotiation between sponsor employer and indemnity insurer.

With this viewpoint, many of the issues and expenses of current practice dissolve. The trustee load is elementary – maintenance of the security level. Investment strategy becomes the responsibility of the sponsor, managed in accordance with their operational plans and performance. With no exposure to the arbitrary bias and volatility of market discount rates, these would reflect proper concerns for stability in security value and income and return prospects. It would also reflect the timescales of commercial and industrial investment.

There is a further concern for trustees, which is summarised in the adage that a fiduciary is as a fiduciary does and means that if trustees create an expectation through their actions and statements, they may well be held to delivery of it.

Much more might be said, and many other apparently problematic issues covered, but this is just a thumbnail outline and fuller detail will be contained the response to the Green Paper, PPF levy consultation and PLSA “Consolidation” paper, that Iain Clacher and I are preparing.

Let us not lose sight of the fact that DB pensions are far more efficient when correctly organised, structured and regulated than DC – if a hundred pounds of pension costs thirty pounds to deliver under individual DC, that same pension may be delivered under DB for approximately fifteen pounds – even today. This is a prize worth having.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to Con Keating on integrated risk management-(@PensionPlayPen lunch).

  1. Mike Lacey says:

    I found the discussion fascinating – thanks to all who contributed, and thanks for not laughing at my attempts at contributing…

    Looking forward to the next one.

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