The damage done to pension funds this year

The Ft has run a story based on the  published group accounts of BT,

“Following the year end, there was a significant fall in the value of the scheme’s assets, during a period of significant market volatility in the second half of September,”  “Prior to the Bank of England’s gilt-market intervention, there was an estimated £11bn fall in the value of the scheme’s assets.”

In very blunt terms , the assets of the BT Pension Scheme stood at £57bn in June 2021. At June 2022 they stood at £47bn. At he end of September they stood at £36bn

That’s a fall of 37% from June 2021 compared with the average fall of pension schemes (measured by the PPF Index over the period of 18.5%

Over the period since June. the  PPF index is down 9.5% and BT’s pension assets are down by 23.4%.

These are eye-watering numbers and eye watering differences.

Something has happened at the BT pension scheme and it’s in the public interest to understand “what” and “why”.

This is how the FT reported what has happened

The drop in assets followed a year in which the scheme’s assets had already fallen by £10.4bn, which BTPS attributed to “the performance of our liability hedging investments”, corresponding to an earlier rise in gilt yields.

Following the year-end, there was another significant fall in the value of the scheme’s assets, during a period of significant market volatility in the second half of September, BTPS said. “Prior to the Bank of England’s gilt market intervention, there was an estimated £11bn fall in the value of the scheme’s assets,” said BTPS.

“Our hedges have continued to perform as expected, and up to the date of signing there has been no worsening in our estimated funding position.”

This blog goes into a little detail to speculate on what that might be, not for sensational purposes, but because there is a body of expert opinion that is stating that “useful content on LDI can only be published by experts. This is not a healthy state of affairs, the assets and liabilities of pension funds are our business, the money that the BOE and Treasury use to protect the financial system is – in the final analysis – our money!

My analysis of what I can read in BT’s group accounts (and the BTPS accounts)

Here are the assets of the scheme as at March of this year (taken from page 171 of BT Group Accounts).

They show that only 6.7 bn of BT’s assets were quoted. Which suggests that the £11bn fall in assets from June to September and whatever was sold from March to June to meet collateral calls on the £31.5bn portfolio of gilts and bonds wiped quoted equity and required a fire sale of gilts. The alternative is that BTPS managed to realise some of their illiquid investments (which is unlikely at short notice) or there was a substantial line of credit from BT group (unlikely but possible).

Although all this is bad news, there was also good news. This is how BT presented its funding position.

The scheme’s funding position, which compares the market value of assets with liabilities, was 92% at the end of the reporting year on 30 June. The scheme paid out £2.5bn in benefits to members over the past year.

In a section of the report titled “Supporting the scheme in uncertain times” the BTPS chief executive, Morten Nilsson, explained that various hedges  were in place as the value of the assets took a significant financial hit.

“Almost all UK DB (defined benefit) schemes hedge their interest rate and inflation risk using a combination of these gilts and interest rate and inflation swaps – financial instruments that we use to protect the scheme from changes in interest rates,”

said Nilsson.

“During this time, our hedges have performed as expected, and whilst the value of the scheme’s assets has fallen over this period, there has been no worsening of our estimated funding position.”

Indeed, the funding ratio has improved. Since the CEO wrote this, the gilt rate has increased further, it is possible that the BT deficit (based on a gilts + discount rate) will have turned to a small surplus. This tells a story about pension scheme accounting.

A scheme that has seen its assets fall from £57bn to £36bn can report a successful year because its liabilities have shrunk by even more than the assets. Is this the proper picture?

Has there been a real fall in the liabilities of the Scheme?

There is a possibility that there will not be so many pension payments to pay in years to come and many of the payments will not be fully inflation linked (some will show 5% increases, some 2.5% , some 0% depending on the complex rules governing indexation). There is also a likelihood that the longevity of BT pensioners has been lower than expected due to the pandemic and its long tail (excess deaths are up in 2022).

But the vast bulk of the reported decrease in liabilities will not be real but based on the abstract valuation of the liabilities – based on gilt yields.

BT pensioners and deferred pensioners have 37% less assets backing their liabilities than they did and that is not a good news story when they need more rather than less pension to meet the rising cost of living.

So what happens if those gilt yields change again?

We hope that what happens is that as the need for the collateral falls away, money currently sitting outside the scheme will be returned and BT will be able to repurchase some of the assets they’ve sold – this is how things are supposed to work.

But gilt rates could spike again – perhaps increasing to a point that there is neither sufficient capital or much left in the locker to sell, in which the scheme will have to call upon BT itself for a line of credit – or risk losing all the synthetic gilts in the liability matching portfolio and the collateral to boot.

In another scenario, gilt rates remain the same so the money remains in the collateral account and BT has to scrabble around to meet their £2.5bn+ pension payments from the depleted assets or from the sponsor.

The £11bn is a real loss of assets, whatever happens in future is speculation.

Has the BT scheme taken a £11bn hit?

I hope my analysis is clear. The £11bn hit looks like sales of assets to meet collateral calls plus a write down of the value of the bonds following the loss of confidence from the bond markets in UK Government debt. This is real money and it is a real hit.

The only thing that is keeping the BT scheme’s funding rate where it is , is the gilt rate. Liabilities may have gone down slightly but in nominal terms the BT pensioners are still out there getting paid their pensions.

The scheme’s asset allocation strategy will now need to be recovered and  the prospects for the future look difficult. The scheme’s collateral account is hostage to the markets, the scheme could still find itself with a theoretical surplus but having to sell off more gilts to meet its obligations to pensioners.

Nobody is saying this scheme is bust, but it’s clear that what’s happened to it over the past year and in particular since June has been immensely damaging. Remind yourself of the performance of scheme assets relative to those of the average scheme (PPF index) above.

The scheme’s asset allocation to gilts and illiquids in March, shown above, suggests it was badly placed to meet cash calls and almost certainly got caught having to sell gilts into the “doom loop” or dip into its store of illiquids (at a discount to book value). Certainly it is not as well placed going forward as had it not been encumbered with LDI.

It’s also worth noting that whatever the Trustees wanted to do with regards ESG and “building back Britain through the provision of productive capital” has been severely disrupted by the “£11bn sell-off”.

All of which means that the FT’s headline is not scaremongering – as many of the 153+ comments suggest, but an accurate report of a very real damage done to the asset base of one of our largest DB pensions. This damage seems mainly attributable to Liability Driven Investment.

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 The damage done to pension funds this year

  1. con keating says:

    Henry – Be a little wary of the PPF asset number. It is heavily caveated by them. The method by which it is calculated is not well suited to the circumstances and markets we have seen recently. It should be regarded as a low estimator of the impact of those events.
    As for BTPS, it is not possible to separate the general declines in asset market prices effects from those arising from swaps and other LDI strategies from the accounts. It seems to have had relatively modest leverage in cash rather that derivatives terms – ~15%. All of that said, the overall result is towards the high end of what Iain and I were expecting.
    I know of rather a lot of people who would like to see USS’s end September interim numbers

  2. Peter Tompkins says:

    You don’t stress the real point here. Liabilities aren’t artificial discounted estimates of future cash flows. They are those actual cash flows. And the cash flows from the index linked assets are still unchanged. So the members don’t have any change in their confidence of receiving the pensions as they fall due and the investment income comes in.

  3. Adrian Boulding says:

    It seems to me that DB schemes have suffered two sources of loss in this month’s debacle. Firstly, some schemes have had to sell growth assets for cash at depressed prices in a fire sale to meet collateral calls on their hedging strategy. Those losses have been crystallised now. Secondly, some schemes have had to reduce the leveraging on their hedged positions. If gilts yields drop back down again while they are partially un-hedged, then at that point they crystallise the damage from the losses we have been seeing in the gilt market.

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