Honey I shrunk the deficit



I grew up in a rural area where the farmers ruled the roost. “You’ll never hear a farmer tell you he’s doing well” my mother was wont to tell me. It was true; when times were bad, they needed subsidy and when times were good, they were quiet. Pension schemes have that in common with farmers, employers hear a lot when schemes are underfunded and have had to cough up large amounts at the behest of trustees and the Pensions Regulator. But when times are good, there’s a hush. Say it quietly but there’s a hush about pensions right now!

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.

Most impressively of all, USS, the largest privately funded defined benefit pension scheme has seen its funding position improve from a £14.1bn deficit to a relatively affordable £1.6bn in the two years to March 2022.

What has been shrinking these deficits and will they remain shrunk?

The deficit has been shrinking because the discount rate used to value liabilities has been rising and that’s because of inflation. Despite awful conditions in the equity and bond markets, the impact of increasing the liability discount rate has prevailed. If inflation persists, and most economists reckon it will stay at 3-4% for some time to come, then liabilities will remain much lower. If assets recover, as is likely as the impact of recent events recedes, then surpluses look sustainable. So, what does this mean for corporate pension strategies

Well firstly, it looks increasingly likely that many employers will have the option to offload their pension schemes onto an insurance company who will guarantee to pay pensions to staff under the tough solvency rules of the PRA. This will mean a radical reduction of the costs of running and funding pension schemes, money that theoretically could be put into the modern DC workplace pension schemes we use for auto-enrolment. This would go some way to bridging the gap between the well-heeled pensioners in DB plans and those who have relatively small pots with which to buy a pension.

Secondly, it will mean that many employers will be able to take corporate decisions such as paying dividends, acquiring companies and launching research programs without having to consult pension scheme trustees, whose requirement for a sponsor will be much diminished. Many pension schemes aim to be self-sufficient from their sponsors even if they are not aiming to be bought out by an insurer.

And some schemes, which put their members first, will choose to distribute their surplus’ by way of one-off bonuses to lucky pensioners by way of a discretionary increase in pay-outs.

But are these surpluses (or mightily reduced deficits) sustainable? Some argue that the deficits were over-inflated by mark to market accounting methodology which forced trustees to report their funding position as if the scheme had to wind up tomorrow. Critics of this approach say that it forces companies to over fund their pensions so that there is a huge buffer against further bad times.

They also point out that this type of valuation leads to large amounts of the scheme’s assets being invested in non-productive capital such as corporate and public debt – and cash. If you take this view, then you will argue that just as the deficits were over-stated, so is the recovery – which is largely down to an improved valuation of liabilities (and not down to there being more money in the scheme).

Based on the scheme not having to close but being valued on a discounted cashflow basis, the actual funding position of DB pension schemes has been consistently positive for several years.

Source – First Actuarial Best Estimate Index

But whether you use the best estimate or buy-out method of valuation, the facts are the same, because of heavy deficit contributions and the “shot in the arm” of high inflation, defined benefit pension schemes are looking in better shape than at any time this century.

But don’t expect your trustees or the Pensions Regulator to tell you that!


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 Honey I shrunk the deficit

  1. John Mather says:

    What expectations do you have for the value of the pound over the next 5 years?

  2. con keating says:

    All of those LDI hedges – of interest rates and inflation – will now be costing schemes dearly!

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