The Killing of Open Schemes – Michael Bromwich



Michael Bromwich

Michael Bromwich has been the CIMA Professor of Financial Accounting  at the  LSE since October 1985  . He is the co-author of “Management accounting in a digital and global economy” and one of Britain’s authorities on the subject. His thoughts on the DB Funding Code of Practice Consultation are laid out below. I think it the best synopsis of the situation I have seen. 

The role of this   code, the principles for which were published for consultation in March 2020, is to give guidance on how to comply with the law including the Pension Schemes Bill currently before the House of Commons after consideration by the House of Lords. Those following different approaches to the code need to show the Pensions Regulator that the legal requirements are satisfied.

The code builds upon the Bill’s fundamental new requirement for DB schemes. This requires that the Trustees must have a strategy to ensure that benefits over the long term can be provided. This strategy must specify the levels of investments and funding that they intend to achieve at the relevant horizon.

The code offers two approaches to regulatory review:   a   fast track review and a bespoke one. The fast track approach requires a scheme to follow the code and agree to the Regulator’s considerable prescriptions for fast-tracked schemes. These schemes will be subject to only a light touch review without the need to justify their methodology.  The bespoke approach is for schemes that do not feel that the fast track requirements are appropriate to them. These will be subject to intensive review and require deviations from fast track to be documented and justified.

The code   enacts the long-term strategy obligation of the Bill by requiring that schemes have a specific long-term objective (LTO). The code requires that  all schemes   adopt as their LTO a self-sufficiency (SS) position (low dependency basis (LDB) in the code) relative to  the sponsor with a low risk portfolio   at   some horizon and  that they  plot the journey towards this.

Bespoke Approach

This option caters for both open schemes and   long-lived closed schemes. Open schemes cover a wide range of arrangements, the major of which include those closed to new entrants but allowing further accruals by   some or all active members and those also open to new entrants. Many of these will be the larger schemes. Several critics have argued that   large but immature schemes with a strong covenant having   good long run visibility would not be   acting in their members best interests by    pursuing an LTO based on a self-sufficiency or low dependency basis. It has also been argued that such schemes should be free to have a long-term recovery plan.

The code’s reasons for adopting a self-sufficiency LTO for open schemes seem weak. That is that this would help planning for the possibility of closure to new entrants, avoiding the funding and investment cliff edges with such a closure and making the LTO a consistent requirement on all schemes.

Comparison between Fast Track Requirements and the Characteristics of Open Schemes

The table below compares the likely major fast track requirements with the general characteristics of a generic version of open schemes which allow new accruals and new members. The fast track requirements will be used to benchmark bespoke schemes.

Comparison between Fast Track and Fully Open Schemes

Scheme Characteristics Fast Track Typical Fully Open Scheme
Ultimate objectives Buyout or run off Run on
Long term objectives SS/low dependency Various
LTO requirements:
Dependency on employer(s) Low or none High and continuing
Resilience to risk High  May be low
Asset portfolio SS or Gilts High in growth assets
 Length of remaining life Short when mature Continuing
Matching assets and liabilities Yes, tending towards with maturity Only for pensioners, if applied
Maturity rate of return Gilts+0.5%-0.25%  Prudently set by trustees and covenant strength
Technical Provisions requirements:
 Growth asset returns  Gilts+1.2%-1.35% given as an example Set by trustees/covenant strength
 Ability to take risk Slightly higher risk allowed with immaturity, non-dependency on covenant is preferred but currently allowed, more risk taking with stronger covenant subject to visibility Covenant strength and trustees’ risk attitude
Market assumptions Set by Regulator, scheme specific assumptions set by trustees Set by trustees
Proportion of growth assets in portfolio at maturity 20% Higher or high
Visibility horizon 3-5 years As long as 30 years
Discount rate  Tending to SS rate, at maturity SS rate Gilts+ or portfolio performance with prudence or dual rates for active & deferred members and for pensioners in payment


  Outperformance No Matter for trustees with a strong covenant but prudent
Recovery plan requirements:
 Length  With a strong covenant no longer than 6 years, preferably substantially less, where covenant is weak, may be longer Up to 20 years with strong covenant
Out Performance No Matter for trustees and sponsors

mb source

As indicated in the second column there seem a very large number of prescribed items for fast track (not all have been listed) relative to those that some other regulators seek to control. There is little evidence in the consultation that these will be applied flexibly thereby stifling innovation. This approach may encourage a tick box approach and boilerplate presentations.  It also reduces the ability to reflect the specific natures of individual pension schemes and those of their sponsors.

The second and third columns suggest there is not much conformity between fast track requirements and the    characteristics of open schemes especially those which give real freedom to scheme trustees.    Substantial areas of direct conflict emerge. This is not surprising as the two types of schemes are seeking to achieve rather different outcomes. Fast track is aimed at schemes that intend to either in time to go into buyout or to wind up within a reasonable time whereas open schemes  are perpetual or long-term going concerns.

The Bill gives additional powers to the Regulator to give a direction requiring the trustees or managers to revise the scheme’s funding and investment strategy in accordance with the direction. The code makes it clear that the individual infringements of any of several of the requirements will place schemes in the bespoke category.

Reviewing Open Schemes

Bespoke schemes will be evaluated on each fast track requirement but also holistically   which may allow the scheme to be deemed as good or better than fast track on an overall basis. This implies that poor performance on some criteria can be offset by either by better outcomes elsewhere or by mitigating actions and additional support. It is not clear what good means, presumably as an overall objective it means likely to achieve an equivalent to the fast track LTO. This is and will be  very expensive for open schemes  focused on growth both in monetary terms and foregone returns  In the code this  objective  is taken to require that  risk higher than that allowable under fast track will be  compensated for by a stronger covenant, mitigating actions and  extra support preferably in the form of legal guarantees  or contingent assets though contingent  contributions will also be considered.  An exercise in seeking to change tigers into leopards   by changing   stripes into spots.

Some commentators have argued that if schemes want to take extra risk they should not complain if the Regulator lays down conditions. This fails to recognise the differences between the two types of schemes. This difference was recognised in the House of Lords where the Bill was amended to allow schemes open to new members   to escape these requirements including by saying that:

open schemes are to be treated differently to other schemes, liquidity is to be balanced with maturity and risk should be correlated with maturity. However, this and other amendments may be overturned in the House of Commons.

The Regulator is especially concerned about schemes with planned long recovery periods and those relying on strong covenants. This denies long lived schemes of one of their advantages-time to react.

LTOs for Open Schemes and Conclusions

The difference between the two types of schemes can be seen by seeking an LTO for bespoke schemes. The pensions literature has not really addressed this question for    going concern pension schemes. Accounting and the law have difficulty with this for going concerns. Corporate boards are required to state in their financial reports that their organisation is a going concern for the foreseeable future.  Pragmatically this is taken to mean one year from signing the financial report.  Similarly, long-term viability statements issued by PLCs generally extend only over three to five years.

One candidate   for an LTO would be to focus on the fundamentals of all schemes  the  cashflows and determine the Technical Provisions with   a 20-or 30-years’ decision horizon with a discount rate based on the long term  portfolio it is planned to hold  in steady state and the journey planned to this point monitored over time. The reliance expected to be placed on employers could be calculated on this basis as could the resilience of the scheme to shocks via scenario testing. The Regulator also would have to be assured about strength of the covenant   and the investment income and the associated risk.

The Regulator would have to be assured about strength of the covenant   and the investment income and the associated risk.  There are other LTOs that could be investigated as could having no LTO and just satisfying the requirements of the Bill.

Without an attempt to better model on-going schemes, many open schemes will be forced into a setting not designed for them and will be forced to close.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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3 Responses to The Killing of Open Schemes – Michael Bromwich

  1. ConKeating says:

    An excellent blog. Though not mentioned, it makes it clear why the Bowles amendement should be retained in the new Pensions Schemes Bill.

  2. Byron McKeeby says:

    I too welcome Emeritus Professor Bromwich’s entry into this important pensions debate.

    I trust this is not special pleading on behalf of certain large private (and public sector like LGPS) DB schemes with friends, dames and lords, in high places, like the Nuclear Decommissioning Authority, Railpen, USS etc.

    I also welcome an accountant’s perspective on this, although I think Bromwich approaches from the side of management (internal) accounting as opposed to financial (external) reporting to shareholders and other stakeholders.

    Bromwich is associated with a “strategic” form of management accounting, making comparisons with peers (not the Lords variety) and markets.

    For example, the recently reported performance of USS Investment Management averaging 6.19% pa over the five years ended 31 March 2020 could be compared with some sections at Railpen which averaged 1% pa more than USS over the same period. I suspect in both cases, however, these are time-weighted returns rather than the more appropriate capital-weighted returns which would be more consistent with how actuaries discount pensions liabilities.

    I’ve often pondered how financial reporting might show a pension scheme as an “asset” in the sponsoring company’s balance sheet, instead of the liabilities (deficits) we’ve become so accustomed to.

    To do that, using the very low yields on present-day AA corporate bonds, I think companies would need to allocate an awful lot more capital to their pension schemes.

    Keating & Clacher have estimated deficit repair contributions by companies since the Pensions Act 2004 of around £200bn or more.

    Financial reporting would also need to deduct (deferred) taxation on the asset (surplus) after dealing with “trapped surplus” which can’t be taken into account.

  3. Derek Benstead says:

    Of course it’s not special pleading. Private sector workers have no less need of a reliable income for life in retirement than workers in public service. If the pensions industry is to be worth the fees it charges, it needs to have an expertise to offer in return, in providing pensions (not savings accounts) to large numbers of private sector workers in a cost efficient manner. This requires affordable open schemes. Current and future generations of workers in the prviate sector have no less need of pensions than past generations. That current and future generations are not being served by the pensions industry, TPR or our legislators is a giant failure.

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