You know the film..

Read Stephanie Hawthorne’s article on whether schemes will pay discretionary interests to combat the cost of living crisis that many members face.

Then ask yourself this. How likely is it for your DB scheme to pay out anything more than it has to, after just meeting its collateral calls to keep its hedge in place?

Back in June when interest rates were increasing at an orderly rate and trustees were thinking about trapped surpluses, this headline made sense

Six out of ten DB schemes mull discretionary increases

Today, with the cupboard bare, schemes may be wondering where the liquidity is to meet next month’s pensioner payroll.

The pace of events has been so quick that an article that might have been appropriate in September, makes no sense in October – no sense at all.

Unless you resisted calls to add LDI to your investment strategy, (and we know a number of schemes did), the recent increased in scheme solvency have been at the expense of scheme liquidity. There aren’t many liquid assets left in some DB schemes.

With due respect to Hilary Salt, many trustees and scheme managers will read this statement as of academic interest.

Those schemes for whom this may be relevant are those that have stayed open and are enjoying the free ride of rising interest rates because their sponsors have stood by the scheme and the trustees have not put it on fast-track to buy-out. For many years First Actuarial have pointed out (via FABI) that schemes were funded to meet their liabilities, were they only given the time to do so.

But Hilary’s voice and the voice of others were ignored. I have heard Hilary talk of how surplus’ can be distributed, she talks to her schemes. Many may now wish she had been advising them. But those that did are (in the corporate sector) few and far between.

The dust is yet to settle but estimates of the liquidation of scheme assets to meet margin calls vary between £200bn and £500bn, but of course the bulk of schemes have unlimited liability to increases in gilt yields and are entering next week with their fingers firmly crossed. All the money sent to the LDI managers for onward transmission to banks may be for nothing if the tolerance of the scheme to increases in the gilt yield are exceeded. Then schemes will be left with seriously depleted assets and no hedge, the worst of all worlds. Will schemes be thinking about discretionary increases – I don’t think so.

I actually had discretionary increases on my list of things to discuss at the PLSA last week (when I accepted an invitation to speak on cost of living). I took it off the list at the end of September.

I notice nobody on the panel , let alone in the audience, mentioned them.

Just what will be bought out?

The exhibition hall at the PLSA was crowded with the stands of insurers offering schemes a chance to talk about the buy-out of their liabilities or a buy-in. Insurers do not want pension liabilities but are prepared to take them to get at scheme assets. If scheme assets are depleted , then the prospect of buying them out takes on a different complexion.

Stephanie worries

Perhaps it is time for a pause for thought rather than a Gadarene rush to buyout? This week’s LDI leveraging hiatus (I warned of the risk in) shows we ignore systemic risk at our peril.

She may have no need to worry. If the LDI leveraging is a hiatus, it will be because the 5% gilt yields that prompted it are an aberration. If that is the case, when the tide goes out , a lot of schemes are going to have to reveal whether they have their bathing suits on. The long queue to buy-out may turn out to be a long queue for more funds from the sponsor with the insurers politely turning away.

It is not just the discretionary increase that may have been a chimera, so might be self-sufficiency and the opportunity to pre-pack the pension scheme off to a third party.

I do not hear this conversation on the lips of trustees or consultants and I don’t hear it from the Regulator either. Maybe I am the idiot boy who has missed something. But were this Government to decide to conduct its financial affairs with a semblance of good order, might the cost of UK borrowing revert to the mean?

Could the trend of this graph be reversed?

Is the outlier really the new normal?

When the top of the spike is reached, schemes will come down with a bump. Right now it might be nice to indulge in a little make believe, but honeymoons don’t last for long ,as certain politicians are finding out.