On 03 March 2020, the Pensions Regulator (“TPR”) launched its consultation on clearer DB funding standards. The documentation included a report from GAD (the “report”) entitled “Modelling the Long-Term Funding Objective” dated 14 February 2020. This short piece concentrates upon the report but I will comment separately on the consultation later.
Representative Scheme The report is based upon a “representative large mature closed scheme” [2.2], with around “10,000+” members (Appendix A), all of whom are pensioners (current or deferred). No future accrual has been included so that this is already not representative of many different private sector pension schemes. Further, using one undisclosed age/service combination is also unrepresentative. No statistics are provided about benefits (amounts or pension age). Using such a simple unspecified dataset to project results for many widely varying UK pension schemes as a whole is too simplistic.
Modelling Methodology That a stochastic process has been adopted is good but 1,000 simulations seem on the low side. How correlations were handled has not been explained. The results published are limited and it would have been helpful if variability had been shown in all tables, together with an indication of how often the funding would have exceeded the target. Showing results as sterling amounts, for example £47 m and £38 m in the top line of table 6, is not helpful without somewhat more context than that the initial central low dependency for this membership was £634 m. Varying the initial central Low Dependancy could have been informative.
Current Market Conditions In [2.12], they state that they imply that UK interest rates, presumably those in 2018, will stay low for decades; can that really be inferred?
Liability Assessments Extracted from Appendix A, the assumptions are hard to discern transparently. The scenarios are stated to have been based upon Moody’s “Best Views” calibration adjusted such that the path of interest rates more closely match market yields. It is not clear whether those market yields were those as at 31 March 2018 or at some other time and the adjustments make it hard to understand what has been done. It is surprising that RPI is assessed from gilt curves, presumably from yield comparisons, because this has been shown not to work at all well (ukrpi.com). When the report was issued, it was already known that there would shortly be a consultation (since launched) on how the RPI might be modified, which would appear to be highly relevant. That CPI has been assumed to increase at 1.1 % pa lower than RPI is startling because there is no evidence for that.
Asset Assumptions For the core portfolio, it is assumed that 80 % would be held in gilts or LDI securities but the gilts have not specified as either conventional or index-linked. The return seeking assets are divided between 10 % in global equities, with around 3 % in each of US High Yield Bonds, Hedge Funds and UK Property. One must wonder whence such an assets distribution was derived because it is very far from common and out of line with figures 7.2 and 7.3 of the Purple Book 2019 (2018 or 2019). Although I had expected to see the asset returns, the presentation format does not permit the reader to identify the assumed risk premia.
Conclusion The report is based upon where TPR thinks they would like to be. However, no account appears to have been taken of where UK schemes actually are, which would have been a better starting point. Not stated, the report seems designed to support TPR’s preferred outcome but, as presented, I suggest that it does not actually achieve that objective.
While the urgency surrounding the TPR consultation has been removed with the postponement of the response deadline till September, I welcome Jon Spain’s comments as well as his earlier comments on the related paper which Christopher O’Brien presented to the Institute & Faculty of Actuaries on 9 March 2020.
Well before the Covid-19 lockdown, I had asked around most of the UK’s leading actuarial firms, and not one of them had performed any peer review or other critique of either of these papers, something which sadly comes as little surprise, but disappointing all the same.
“The report is based upon a “representative large mature closed scheme””
There’s a significant problem right there. We need a regulatory system which regulates the existence of DB pensions, not one which regulates DB pensions out of existence. People need pensions – the role of the pensions industry should be to provide pensions, efficiently. The fact that the large majority of private sector DB schemes are closed to new entrants or closed to accrual does not justify the regulatory focus on closed schemes. The focus should be on developing a regulatory system in which private employers could sensibly choose to provide a pension (meaning an income for life, as opposed to a pot of investments inside a tax wrapper). This means focussing on the needs of open schemes notwithstanding open schemes are in a minority.
Well said, Derek. I look forward to reading First Actuarial’s response to TPR’s consultation when it ends later this year.
Thanks Dereks – the view of the pensioner is important in this – let’s hope tPR remembers their statutory duty to members to protect their pensions https://henrytapper.com/2020/04/22/almost-a-quarter-of-australian-seniors-have-run-out-of-savings/
TPR has multiple objectives, Henry.
The one you cite is the first, but not necessarily overriding all others:
The regulator’s statutory objectives are:
to protect the benefits of pension scheme members
to reduce the risk of calls on the Pension Protection Fund (PPF)
in relation to the exercise of its functions under [the statutory funding objective], to minimise any adverse impact on the sustainable growth of an employer
to promote, and improve understanding of, the good administration of work-based pension schemes, and
to maximise compliance with the duties and safeguards in the Pensions Act 2008.
Your former colleague at First Actuarial is arguing in favour of at least including some of the others in a meaningful way. TPR also contradict themselves elsewhere in regulations by emphasising “The trustees’ key objective is to pay promised benefits as they fall due”, which does not necessarily mean they have to be fully secured at all times.
I have to agree totally with both Derek’s and I am pleased Derek Scott has listed the Regulator’s potentially conflicting Statutory Objectives. I have lost count of the number of times I have had to remind commentators and Regulator employees of these. TPR has unfortunately not fully grasped the fact that Employers having established their DB schemes in the first place might actually have done it for the right reason, and should be left to agree appropriate funding with their Trustees. There has been an obsession with a view that gilts are low risk and an appropriate tool for valuing liabilities and corporate bonds as being a suitable benchmark for valuing liabilities for company accounts. They are not, the trend to negative real returns highlights the absurdity. . . .
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