Say it quietly but the outlook for our defined benefit pension schemes is improving. Members , trustees and sponsoring employers can be heartened by five concurrent signals – all of which suggest that the cataclysm predicted last year by Cass Business School and others , is proving “fake news”.
- Mortality is improving but not as fast as we’d expected
- Equity markets are buoyant and bond markets stable
- Costs of management are falling
- The PPF is thriving
- Accounting deficits will benefit from high levels of CETV take-up.
Taken together, the pressures on schemes should reduce. Trustees could regain their mojo to invest for the long-term and resist de-risking.
Members may regain confidence to stay put and employers may get some balance sheet relief (and lower cash demands from recovery plans). There are a lot of conditional here, but this is a blog not an economic forecast.
Let’s take each signal and test my case;
Hymans Robertson, who share data from their Club Vita project, started talking last year of a slowdown in what seemed an inexorable improvement in British life expectancy. This improvement is baked into most actuarial tables so any adjustment would reduce the valuation of scheme liabilities.
Now the Actuaries own institute has confirmed that
“Recent population data has highlighted that, since 2011, the rate at which mortality is improving has been slower than in previous years”.
The figures suggest that men aged 65 will now live another 22.2 years, down from 22.8 years in 2013. Women aged 65 will now live for a further 24.1 years, down from 25.1 years in 2013.
Actuarial firms vary in predicting the impact of these numbers , Mercer and Aon are cautious and talk of adjustments in liabilities of 1-2%, PWC are more optimistic and suggest they could slice £310bn off UK pension liabilities, reducing their calculation of deficits by 15%. Whatever the impact, there is consensus that this will be positive for immediate triennial valuations.
What of markets?
For all the talk of terrorism, populism and unprecedented uncertainty, the markets have improved. Equity markets in the UK and abroad are at or are close to record levels. This should not be seen as odd, markets are supposed to rise over the longer term as productivity increases.
The fundamentals that drive improved productivity – digitalisation, better education , low wage costs and up-skilling are all working towards higher valuations for company equity and lower risks of bond defaults. The low inflation world in which we currently live may create problems in terms of pension scheme liabilities, but it has meant there is plenty of cash in company coffers to meet cash calls.
There is substantial fat in the management fees paid by occupational pension schemes. This is recognised by the FCA’ Asset Management Market Study which sees Trustees over-paying for both asset management and for investment consultancy fees.
The obvious targets for cost reductions are in alternatives. Last year Chris Hitchen claimed a deep dive into the way “alternatives” managers were rewarded saved the Railway Pension Scheme more than £100 million a year on fees.
Large funds such as the British Steel Pension Scheme and notably the PPF, have insourced investment management from fund managers , making notable savings that have been passed on in improved investment performance to ease the road to self-sufficiency.
Smaller schemes have been able to negotiate fees with asset managers as they see deals available through platforms such as Mobius. Consultancies like my own, that work with schemes with less than £100m in assets have been adopting a rigorous approach to fee negotiation often moving large swathes of actively managed money into passive investments. The greater transparency in the market has given trustees confidence not to take things lying down. There is still scope for considerably greater efficiency in scheme management.
A thriving PPF
The current levy consultation being carried out by the Pension Protection Fund has allowed us to see a fund where management costs are reducing, risk is more fairly assessed and investment strategies are working. The PPF’s aim is to reduce the period till it is self-sufficient but this needs to be balanced by the strain of the levy on corporate P/L.
The levy’s trend is downward. A thriving PPF not only means a better safety net but a cheaper one too.
A word of caution; the PPF can be too cautious and we warn against it drinking its own kool-aid; the levy is too high, self-sufficiency reserving is being set at absurd levels and the investment strategy of the fund is ill-suited to its long-term aims, but in terms of current strain, a thriving PPF can only reduce the burden of DB pensions on employers.
High CETV take-up.
The current CETV bonanza has been variously billed as the salvation of the retail funds industry, the making of SIPPs and a risk-free windfall for deferred members of DB plans.
Actually, CETVs are calculated to be cost neutral at best estimate valuations. Since best estimate valuations are much more favourable than accounting valuations (where liabilities are measured at the risk-free rate), there is almost always a windfall to the employer when a CETV is taken. This is a notional windfall and the long-term impact of seeing a scheme reduce in size is questionable, but employers will be able to book substantial improvements FRS 120 pension numbers as CETVs continue. Indeed many employers have already started booking them, some several years in advance.
Something to write home about
Taken together, the five signals of improvements in DB pension funding are something to write (home) about. It’s much easier to make headlines by doing the Cassandra bit and no doubt JLT will continue to warn employers of the toxicity of their pension schemes for years to come.
However, if I was a trustee or even an employer, I would be sleeping a lot easier today than a couple of years back when all I had to hear was woe!
First Actuarial will continue to publish its FAB index showing that while not all in the garden in rosy, we are a lot better off than the Cassandras would have us. John Ralfe apart, there is an acceptance that pension schemes invest for the long term because they have long-term liabilities. The long-term outlook for the global economy is positive (unless you are Chicken Licken) and it even seems we have over- cooked some of our mortality assumptions. The costs of running a pension scheme should be falling as should PPF levies.
Which begs the question – why are so many people choosing to leave what appear to be perfectly good defined benefit pension schemes?
Shift in life expectancy promises £310bn cut to pensions deficit – FT; https://www.ft.com/content/77fa62fe-2feb-11e7-9555-23ef563ecf9a
IFoA CMI mortality projections (March 2017) ; https://www.actuaries.org.uk/news-and-insights/media-centre/media-releases-and-statements/cmi-mortality-projections-model-2016-launched
A huge pension fund hired an investigator to work out where it was getting screwed; http://uk.businessinsider.com/railway-pension-saved-money-on-hedge-fund-fees-hired-investigator-2016-3