A counterblast to apostasy – Keating and Clacher hold the faith!


A blog from the pens of  Con Keating and Iain Clacher

Henry Tapper has been our eyes and ears on social media and has passed us a variety of questions that have been sent to him on twitter. He’s passed them to us for comment.

I do not understand how an open-ended investment scheme needs new members to make payments to current members. I am thinking that the discussion on open schemes needs some reality checks.

An open-ended scheme does not need new members to make payments to current members. However, it usually does have them and that affords the open-ended scheme greater degrees of freedom in the management of its supporting investment portfolio. That translates into a reduced need for asset transactions and greater efficiency in the management of that portfolio.

As the expression ‘open-ended’ is potentially ambiguous, we will make the point that a scheme could offer perpetual benefits (for example to members and their heirs and successors) and as such would be open-ended. The level of funding needed for this form of open-ended scheme to be viable is a trivial calculation – for nominal ongoing obligations (O) the required funding level is O/r where r is the yield on the portfolio. Slightly more complex formulations are used for real obligations. It will fall short only if the yield on the portfolio is not realised.

Why should pensioners and deferreds have less security in an open scheme than a closed one?

There is conflation of security and the level of funding here, as is evidenced by the next of these questions. No-one is calling for lower security for open scheme members, but similar levels of security usually imply a lower level of funding for an open scheme than for a closed scheme. For the avoidance of any doubt, we are talking of funding as a proportion of the total projected benefits here. This is a mathematical consequence of the relative profiles of amounts and terms of liabilities  in open and closed schemes. To reduce this to a simplistic illustration – if we have to pay £100 next year and we can earn 5% in that year we need funding today of £95.24, while if we have two years before we have to pay this amount we need just £90.70. The perpetuity calculation earlier shows the centrality of the portfolio expected return on required levels of funding – if we require schemes to de-risk and accept lower expected returns, we will massively increase their required levels of funding.

What happens when an open scheme closes and it is more poorly funded than a similar closed scheme at that point?

The short answer to this is nothing. In fact, we would not see a similar closed scheme for this comparison to apply. We have seen many schemes close over the past decades and the world has not ended for them.

If we introduce a new and specific funding regime for closed schemes, such as the de-risked portfolio approaches being promoted by the Regulator under the proposed code, then we will have lower expected returns on the investment portfolio and face demands for increased funding for the closed scheme. This will have costs running to hundreds of billions of pounds.

The costs of the Regulator’s proposed de-risking are outrageous, and the concept is theoretically unsound. If we de-risk and are left with a portfolio with an expected arithmetic return of 1% and volatility of 7% our compound earnings will be just 0.75% pa while if we maintain the existing diversified portfolio with returns of 7% and volatility of 20%, our compound earnings will be 5% pa. In other words. the annual cost of de-risking would be of the order of £77 billion annually. It illustrates just how totally out of proportion the Regulator’s proposals under the funding code are.

 Currently accruing DB benefits get indexation up to 2.5% and a higher cap than originally intended. Plus once over NPA there is no 90% or cap. So PPF provides high protection.

This is telling. It and the following comment would show that this commentator’s concern is not member security but in fact protection of the PPF. In fact, all of these reductions in benefits provided by the PPF are entirely unwarranted. It would then be clear that the commentator (like the Regulator) is completely unconcerned with the cost of schemes to sponsor employers and is condoning the Regulator’s dereliction of its statutory objective in that regard.

Time for reality bites on funding level. There are good arguments for why accruing pensions for younger people should be matched by riskier assets. Let them have them in a CDC format rather than relying on the PPF.

Considering its proposed DB funding code it is the Pensions Regulator who has lost touch with reality; that was why there was so much pushback from all sides of the industry on the funding code consultation. The poster’s final statement suggests an insouciance to the fate of DB worthy of the Pension Regulator.  Unless TPR’s hard line approach softens, then Parliament will be misled. With supporters like this, the Regulator looks set to embark on a journey designed to render the PPF redundant, by way of gross over-funding of DB schemes.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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