There are obviously complications and nuances with any pension scheme. But the fact that an erroneous, ill-timed valuation made #USS benefits unaffordable due to unnecessary deficit recovery payments is as black-and-white as any matter of pensions can get https://t.co/H7RJnnObXS

— Acamedian (@acamedian) May 31, 2022

Black and white

We are therefore confronted with the spectacle of a declaration that costly steps — contributions of at least 6.2% of salaries — must be taken from 1 April 2022, in order to recover a deficit that had vanished into insignificance by the previous day of 31 March 2022 –

Mike Otsuka describes the events of the past three years at USS as “farce”, but I don’t see too many teachers and students laughing.The aggressive tactics employed by the USS executive were overseen by the “Galvinator” as Bill Galvin calls himself on twitter.

Bill Galvin before becoming CEO of USS was CEO of the Pensions Regulator. The Pensions Regulator has, since the 2020 valuation , been armed with new powers to enforce action against schemes and sponsors that are seen to wilfully underfund their pensions. But looking at what proper funding looks like, many trustees and sponsors may well crack a grim smile.

The strain on employers to ringfence their DB liabilities and fund them at any cost is an issue for any employer looking to implement a consistent reward strategy. If a few more mature employees (and a lot of ex employees) are consuming the majority of the allocated pension spend, is it any wonder that DC contribution rates for the remainder of staff are often little more than the AE minima?

While it would be better to have all employees accruing guaranted pensions, the reality is that most employers cannot afford this cost and remain competitive. The cost of contributions has risen because of the way that pension schemes are funded and a side impact of de-risking these schemes to achieve the self-suffeciency that the Pension Regulator sees as a virtue, has been to swap productive capital for debt financing. This creates a greater strain on the employer’s cashflow and reduces the capacity of the scheme to provide the patient capital that underpins many of the schemes of our commonwealth cousings (think Australian and Canadian pension funds holdings in UK infratructure).

Another harmful side-impact of the move to self -suffeciency is the reduction in the discount rate used to value these low-performing assets. Low discount rates lead to high transfer value and high transfer values mean that members and their advisers have used the past five years to transfer pension entitlements to wealth management. We think that up to £100bn has transferred out of UK pension schemes, some of which is now the subject of investigation and judgements by FOS and claims against IFAs by FSCS.

In black and white, the direction of travel taken by an over-zealous regulator and followed by most trustees and their advisers, has led to a DB landscape that is over-funded by any measure. The policy of prudence at any cost has to be seen in the wider context of morality.

Reckless prudence

Here is the latest version of First Actuarial’s FABI index, showing that collectively , DB schemes are and have been in surplus on a best estimates basis since the index began in 2015.

The aggregate defined benefit (DB) pension scheme surplus in the UK increased by £60bn to £190bn in May, according to the PwC Pension Trustee Funding Index. The funding ratio increased from 108 per cent at the end of April to 113 per cent at the end of May, based on schemes’ own measures.

Liabilities fell by £110bn to £1,450bn over the month, largely down to the continuing drop in bond prices. And while asset values also decreased during May, from £1,690bn to £1,640bn, (largely down to the same fall in bond prices), the pension garden is rosy.

What the green line of the First Actuarial graph shows, is that if you take a long view and do not mark your assets and liabilities to the market, you get consistency, in the case of the UK DB consituency, consistent over-funding (at the expense of corporate growth and proper pensions for most staff).

The over prudent approach purused by DB schemes at the behest of the Pensions Regulator is a contributor to Britain’s low productivity relative to its peers, pension schemes have drained corporate cashflows and have withdrawn from supplying capital for corporate growth (swapping debt finance for equity finance). The prudence created has been squandered on over-generous transfer values that reflect the folly of de-risking schemes that might more properly have been run as social enterprises.

All this has been to avoid pension scandals involving large employers dumping schemes into the PPF. The PPF, far from struggling beneath the weight of insolvent pension schemes, is thriving and is well on its way to self-suffeciency. Meanwhile, schemes such as BHS and BSPS, that avoided the PPF to seek buy-out from insurers, have drained sponsors of billions. The informal funding code in place at TPR is consistently intervening in the natural selection of corporates , making insolvent employers  – unable to use the lifeboat set up for their pensions.

So we end up with no local scandals but with a scandalous DB pension system that eats into the productivity of the UK through demands for prudent funding which are reckless.

It is time that we took another view of DB funding, hopefully that will happen when the Pension Regulator admits the folly of its original DB Funding Code, later this year. What we need is a little less prudence and a little more morality.