Scheme Funding – “Law and Practice” or “guesswork”

Ian con

Iain Clacher and Con Keating

The Pension Schemes Bill introduces some new obligations for DB scheme trustees in addition to those already existing in Part 3 of the Pensions Act 2004, which is concerned with scheme funding.

All existing obligations are enduring and the new obligation is short and simple: (1) The trustees or managers must determine, and from time to time review and if necessary, revise a strategy for ensuring that pensions and other benefits under the scheme can be provided over the long term. This is referred to in this Part as a “funding and investment strategy”.

The expression “Long Term Objective” and all that goes with that. ”Fast Track”,”Bespoke”, etc., are inventions of The Pensions Regulator.

The Bill expands this new obligation:

The strategy must, in particular, specify —

“(a) the funding level the trustees or managers intend the scheme to have achieved as at the relevant date or relevant dates, and

(b) the investments the trustees or managers intend the scheme to hold on the relevant date or relevant dates.”

Of course, this is very far from the straitjacket terms of the proposed TPR Code. The present Bill does not even preclude open scheme trustees from specifying that horizon as, say, thirty years from now, and at times in the future, but…

The Bill also grants powers to the Secretary of State to write further secondary legislation, regulations, and lists some that may be enacted. However, that is for another day, a separate consultation and due Parliamentary process. The Bill does, however, specify:

”(b) “relevant date” means a date determined in accordance with regulations.”

The proposed new DB Funding Code sits at the end of this legislation where it should be remembered that, although it must have been laid before and approved by Parliament, it does not have the force of law. It is guidance, albeit offered in a ‘comply or explain’ framework.

With all this in mind, we avidly listened to, and watched the recent TPR webinar on the proposed Funding Code. We had hoped for some rigorous analysis and justification of the need for a different funding strategy such as self-sufficiency (sorry, low dependency) for closed schemes in run-off. We were disappointed. By contrast, we were pleased to hear that ‘prudence’ will be defined in the second consultation on the Code.

We were surprised by the emphasis on the ’fast-track’ as the reference base (it was even referred to as a benchmark at one point) from which all ‘bespoke’ arrangements are to be viewed. This was described as ”objective”.

Later, TPR’s Head of Legal, while describing objective measurement, quoted the following line from the website of the Institute of Objective Measurement:

”The goal of objective measurement is to produce a reference standard common currency for the exchange of quantitative value, so that all research and practice relevant to a particular variable can be conducted in uniform terms.”

Now, that is a description of purpose rather than a definition.

The Institute’s website does offer the following definition:

“Objective measurement is the repetition of a unit amount that maintains its size, within an allowable range of error, no matter which instrument, intended to measure the variable of interest, is used and no matter who or what relevant person or thing is measured.”

But that, of course, would have forced TPR to face the fact that their principal measure, the gilt-relative discount rate, fails this test. Using a market-based gilt rate, the amount returned by accrual of the contributions and the amount returned by discounting of the projected cash flows are not the same.

Had we known that TPR was thinking in these terms, we would have offered to loan them our three-volume copy of ’Foundations of Measurement[i]’. We would have added the caution that its 1,453 pages are mathematically challenging and that after 15 years of effort, those authors abandoned their work on stochastic measurement, as mathematically too difficult. And, of course, the principal measure in the Code, the gilt-based discount rate, is stochastic.

As this term is often bandied around, and its meaning often unclear, we offer the following two definitions from the Free Dictionary:


  1. Statistics involving or containing a random variable or process:
  2. Of, relating to,or characterized by conjecture; conjectural.


These definitions hardly support claims to be “objective measurement”.

The problem is that the value of the gilt yield that we observe[ii] is a probability zero event[iii], and that is hardly the basis for any sound decision. We can and do work with stochastic processes, but when we do so, we use collective statistics, such as the mean, median and higher moments of the process[iv], not arbitrary values from within it. This is the theoretical basis for techniques such as smoothing.

However, for the Regulator there is a far larger problem; this renders baseless any attempt at enforcement based upon these discount rates. ‘Fast Track’ cannot be a valid comparator or ‘benchmark’.

Ordinarily in financial analysis we welcome extreme events as these are information-rich – the further from the mean the richer they are, the more they tell us. However, this information is noise, distorting the values obtained, when used as a measure, as in discounting.

However, all need not be lost. Recognition of this by the Regulator might free us from the tyranny of benchmarks and perhaps even the tyranny of metrics.

Indeed, the elimination of metric-induced herding, goal displacement and short-termism might actually free us to pursue a strategy for providing pensions over the long term.


[i]  Foundations of Measurement. Vols. I. II, III. Krantz, Luce, Suppes & Tversky.  Dover Publications 1979, 1989, 1990.

[ii] Strictly, we observe a price from which we calculate the yield)

[iii] Readers wishing to understand this point more fully are referred to ”Not all probabilities are created equal”  or a good text on measure theory such as:

“Measure Theory and Probability” by Malcolm Ritchie Adams and V. Guillemin,

[iv] We also pay great attention to the error terms of these statistics and the confidence we may place in them.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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7 Responses to Scheme Funding – “Law and Practice” or “guesswork”

  1. Eugen N says:

    I think that before we over-mathematise the problem, we forgot to define what the whole problem as it is.

    There are conflicting objectives here:

    1. employers would like to get rid of these DB schemes, but also to minimise their funding, if possible. More to that they do not like the way that scheme deficit reflect on their balance sheet and influences the profit and loss account. Majority of these businesses are 20thies century businesses in hard decline, which have to compete with disrupting 21st century businesses, who do not have a DB pension scheme to care for.

    2. the tPR is worried these businesses will go bust and the PPF, and ultimately the taxpayer remain on the hook for deficits, risking rising taxes; Apart from that there could be a lot of embarrassment. As a result, they would like that schemes at least get their funding closer to the PPF funding levels, and invest in the same assets like the PPF, because companies usually become bankrupt when there is a recession/depression etc, and similar stock markets are lower.

    3. active member of the schemes. There are two type of active members of these scheme, some companies still allow accrual for older employees in the DB scheme, but new and younger employees are in poorer DC schemes. That is completely discriminatory, and works against the company employing them. These companies cannot reward their newer employees with good pensions as part of the whole package, these employees feel they are discriminated, and could lose these highly skilled employees to other employers who may pay them more.

    There are also schemes (very few) who are still open to new employees too. This is probably what Bowles amendment is all about. I cannot say that the amendment’s intentions are good, but sometimes good intentions are not enough. There need to be a difference between weak employers like USS and Railways, and more reliable employers like Local Governments as for LGPS – where Councils, at least theoretically could raise taxes to pay and/or fund DB pensions.

    It gets even harder when Unions get involved in negotiating assumptions, and funding issues, including not agreeing with increased pension contributions.

    The main problem we need to recognise is that a pension scheme in its format last for as long its sponsoring employer lasts. “Long term liabilities” do not count as investment strategy when a sponsoring employer fills for bankruptcy, as the pension scheme comes to an end, it falls into the PPF or it tries a Regulatory Apportionment Arrangement (RAA), like it happened with BSPS. Sometimes it happens in such a short succession, as was the case with BSPS, which closed for accrual in 2016, and by March 2018, it fails to exist. As a result, DB pension funding needs to account more for the sponsoring employer financial situation, and a lot less for its long term liabilities.

    I think we spend too much time looking at DB pension scheme funding, and a lot less checking on these sponsoring employers and their finances and the probability they could carry these pension schemes forward. I would be more interested to see stochastic simulation on sponsoring employers survivability than modelling stock market returns.

    • George Kirrin says:

      One of the reasons we have “poorer DC schemes” is because TPR is forcing overfunding of legacy DB schemes in many cases. Even i21st century businesses with no significant DB have the comparative bar for DC set low by the misallocations of capital elsewhere between DB (overfunded), business growth (underfunded) and DC (underfunded).

      Can I also correct one other point you make – we taxpayers do not stand behind the PPF. PPF has its own levers (to defer its current self-sufficiency horizon of 2030 and/or to change the 90% roughly of DB pensions it underpins to a slightly lower percentage and/or to increase the annual levy it extracts from the other DB schemes).

      You could also argue that the PPF, which is now one of the largest DB funded schemes in its own right, could have a slightly higher investment return target. Its current target is a mere LIBOR+1.8%, which is roughly 2% per annum. I’m sure your clients would expect higher average returns than that from a lower risk investment approach?

      • Eugen N says:

        The PPF has its own levers when deficits are small, to result in a small levy. When deficits get higher, which is expected as more scheme will enter the PPF, it would be harder to spread the deficits on less pension schemes left standing.

        As a result, there would be only two options left: reduce benefits from 90% to 80% or having a recourse to the public purse. (people posing with their trousers down in Brighton!)

        As I have already explained in my previous post, funding for a pension scheme needs to respond to two key elements: future long term liabilities, and sponsoring employer. My concern is that sponsoring employers would fall a lot faster than their long term liabilities will reduce, and clog the PPF with liabilities.

        These employers are mostly 20thies century businesses, most of them in decline (steel, oil industry, old telecom companies, energy business, railways companies, uncompetitive industrials, also banks and insurers etc), so you would like these pension schemes to be ‘fully funded’ as soon as possible, ideally to be able to pay all benefits or at least pension benefits at PPF level.

      • henry tapper says:

        The point you make about restricting DC contributions is very pertinent and I pick up on it with regards transfer values

  2. ConKeating says:

    We agree that the attention should be on sponsor insolvency rather than funding – prevention is better than cure. One problem with that though is that the PPF is truly useless at corporate finance. They trumpeted the Kodak restructuring which has come home to roost in their largest ever deficit ($1.5 billion)
    I will correct you on one point – USS as a last man standing arrangement is not a weak employer. It has the advantage of being in a business where the failure of some benefits the remaining. It is unlikely ever to fall below A. I expect some 20 or so universities to fail. The open question is how we best resolve them.
    Few schemes willingly closed. It was the obscene and incorrect costs under regulation and accounting which created the conditions for that. The introduction of the lifetime allowance which effectively excluded management from these schemes removed a material barrier to closure.
    I would be happy to offer insurance which would substitute for the employer as guarantor – and it would not cost very much, less than 0.5% pa of liabilities. Just a variation in ‘rent-a-captive’.

    • Eugen N says:

      The last man standing arrangement would be hard to enforce in case of a 20% insolvency. This is why pension advisors for well funded Universities are selling to them the option to get out of the USS, and have their own pension scheme, either DB or DC.

      As a result, in my opinion, the USS has one of the shakiest foundation, and its funding needs addressed quickly or the scheme closed for future accrual.

  3. ConKeating says:

    You make a good point about the PPF expected return of assets of LIBOR +1.8%. The return on capital of UK private non-financial companies has typically been around 10% for the last decade or more. How then does TPR possibly justify a strategy of maximal funding?

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