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.