Extreme investment caution’s killing off final salary schemes – Boulding.


Adrian Boulding


Extreme investment caution is killing off final salary pensions, believes Adrian Boulding – and, within that, there is a stark message too for the defined contribution saver.

Adrian is a long time friend of this blog and I’m pleased he’s happy for this fine piece to be published here (thanks to Dunstan Thomas and Retirement Planner too)

The strange and bizarre world of final salary pensions continues to throw up surprises. Open a newspaper at the City pages and you would think the schemes were in real trouble.

Talk of deficits abound. The government has consulted on a Green Paper that asked questions about the affordability of pension promises already made, while defined benefit (DB) workplace scheme closures continue to grab headlines. Just recently, while reporting their half-year company results, another great British engineering company, GKN, announced its final salary scheme was closing to future accrual.

Yet turn to the personal finance pages in the very same paper and you can find quite a different story. People are being offered very high transfer values to give up their DB pensions. It is regular to hear of transfer quotes of 40 times the pension being foregone, and recently I was shown one of 45 times.

Now, clients actually getting their hands on all that lovely lucre may currently be difficult – but the paralysis in the transfer market is caused by regulatory fear and that is a topic for a different column.

For now, let’s keep our eyes firmly focused on the final salary schemes and ask whether quantitative easing, or QE for short, really is the cause of the problem. Many will argue it is, and point to the very low returns available on gilts today. And it is certainly true these rates are lower than was foreseen when companies set up their final salary pensions a generation ago.

Around 30 years has passed since a formative day in my own actuarial training, when I asked questions about how the insurer that employed me was pricing its guaranteed annuity options and was told by a most eminent actuary: “Adrian, gilts will never go below 5%.” Today a 15-year fixed interest gilt offers 1.75% a year and the index-linked version a real return of 1.5% a year below inflation.

The mathematics is clear – if the pension has increases that are inflation-linked, or fixed increases of 2% or more, both of which are fairly common for DB, then gilts just do not keep up with the payments! Hence the reason surprised members are being offered a transfer value that is rather greater than their first year’s pension multiplied by their life expectancy.

And this is why so little of my own SIPP is invested in gilts. Or in a bank or building society account where, according to the Bank of England, most providers pay less than 1% and the average is just 0.15% a year. There are so many more exciting investment opportunities out there – as a quick glance at any financial magazine or website will show you – and yet final salary trustees, having taken professional investment advice, so often plump for the low-return options.

Again, we have to be careful not to confuse surface noise with the root cause. It is easy to attribute these ‘safe’ investments to the natural caution of trustees; or to The Pensions Regulator’s guidance the employer covenant needs to be carefully considered before trustees take any investment risks; or even accounting standards that encourage employers to seek liability-driven investment approaches to minimise year-on-year ‘shocks’ to the company balance sheet.

No longer friends

I have come to the conclusion the real cause is the pension fund is no longer part of the business – or even a friend of the business. It has become a rival, seeking to suck up as much resource as possible to bolster the security of the members’ pensions.

Three decades ago, when I gave actuarial advice to a portfolio of schemes, it was common to find the chief executive and finance director sat on the Trustee Board. They often viewed the pension scheme as an arm of the business, and we would discuss pace of funding alongside the firm’s other development priorities and cashflows.

To see how stark the difference has become, let’s look again at those GKN half-year results. The company is achieving a 15.8% annual return on capital employed, which is slightly down on last year’s figure of 16.6% a year.

Those sorts of returns are not particular to GKN – they are commonplace among FTSE 100 companies. No wonder shareholders are fed up with paying into final salary schemes then, when they see the funds invested by trustees earning so much less. Especially as the poor employer has been forced to take out and pay for an insurance policy too in the form of levies to the Pension Protection Fund that will pay benefits in the event of the employer’s insolvency.

There is a stark message in here for the defined contribution saver too. If you are too cautious in your investments, then achieving the sort of lifestyle you aspire to in retirement may well prove unaffordable.

Adrian Boulding is director of retirement strategy at Dunstan Thomas

This article first appeared in Retirement Planner Magazine

For an opposite view – try this – the latest blog from Redington

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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5 Responses to Extreme investment caution’s killing off final salary schemes – Boulding.

  1. ancientllm says:

    Henry, I am surprised that you are decrying gilts as an investment category and noting that DB pensions schemes are returning substantially less than GKN’s 15%. Earlier this year I was one of the judges for Professional Pensions Pension Scheme of the Year Awards (as I have been for many years now). RETURNS on gilts that the best schemes were obtaining were as much as 25% in some cases and certainly the best schemes were returning 10+% overall on their investments. Now I am aware that gilt YIELDS are pathetic, and that you have to keep a very close eye on them to ensure you bail out before the crash, but I would have thought that a DB fund with a decent Investment Team would be an asset to any business. After all, the way that successive governments have limited more and more how much senior management/board members can put into their pension cannot possibly be putting them off having a well funded company pension scheme!



  2. henry tapper says:

    I believe that index linked gilts were the highest performing asset class in 2016 (if you can call a gilt a class of assets).The more experienced investment people tell me (and i am an amateur) gilts are less an investment and more a hedge. The long-term nature of pension scheme liabilities means that investment in real assets is needed. Many of these liabilities will be prematurely met from a buy-out of shunting into the PPF and if that’s the plan, I can understand a gilt-based strategy. But as Adrian says in this blog, DB plans aren’t all heading for extinction (unless we force them all into gilts), most of them have long-term time horizons which aren’t suited by gilts at all.

  3. One must not confuse yield with ‘total return’. The great return in terms of capital gain is only a gain if you sell. If you hold the Gilt/bond until maturity it is returned at par value – a guaranteed capital loss if you have bought above par value (the vast majority are well above par price since the coupon is typically around 3% with some older issues offering 5% or more. ‘Running yield’ takes into account the duration left and computes the expected capital ‘loss’ into the coupon. This tends to mirror the market expectation of average expected interest rates over the life of the bond. No-one refutes the income matching attraction of bonds, but although many pension funds are cash flow negative, they have many options for taking income – dividends; property rents; directly investing in loans, etc. One must also remember that pension funds have to pay transfer values and lump sums and so predicting income requirements is not easy.

    I always felt that FRS17 and its successors were ways for analysts and shareholders to compare ompanies so that meaningful judgements could be made on which company to invest in etc. I never expected Finance Directors/Actuaries and Trustee Boards to blindly follow an investment strategy that seemed to have the only goal of reducing balance sheet volatility, regardless of cost. However, the transparency of pension scheme funding and size of some schemes compared to employers has created a mindset that it is better to kill of schemes and replace them with inefficient DC schemes, rather than provide less generous DB schemes that are more efficient and can take a long term view investing in various asset classes, rather than predominantly accruing more and more bonds due to the accelerated maturity caused by closure. http://www.plumbingpensions.com is an example of a successful long term DB plan that, apart from potential s.75 issues, does very well with low contributions from employees and employers.

  4. Steve H says:

    “I have come to the conclusion the real cause is the pension fund is no longer part of the business – or even a friend of the business. It has become a rival, seeking to suck up as much resource as possible to bolster the security of the members’ pensions.”
    When GKN’s market cap is £5.4bn and the deficit is £1.8bn you should not be surprised at this. When a pension comes into payment, it is too late for a pensioner to do anything about the balls-up by the friendly CEO. Pensioners have to have security. Employees can only afford to be friends of the business while they are working there and for management and trustees to behave otherwise is somewhere between naïve and unethical.

  5. Mrs B says:

    And of you steal from your brothers you can become even richer

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