Once upon a time , the Government used to pay pensions based on contributions made by employers and employees. There was no formal pension fund that backed up this pension scheme but the Government , if it did not have available cash flows from tax revenues, could fund pensions by borrowing – issuing gilts. The name of this scheme was SERPS or the State Earning Related Pension Scheme, it did exactly what it said on the tin but it did not win popularity with the pensions industry and – after a thousand cuts – it died in April 2016.
John Shuttleworth, the noted PWC actuary once told me it was the most efficient company pension scheme in the world, paying pensions at a fraction of the cost of private schemes doing the same thing. I don’t have to labour the point – you can understand why it was unpopular with the pensions industry.
So pension schemes funded by gilts are nothing new and we might ask why it is that so much of the UK pension industry (DB and DC) is paying pensions and annuities or funding for them, using the same security as SERPS?
Surely the rationale for having private sector pensions is that the private sector creates the economic wealth that enables pensions to be paid to those who work in it. Why should our large companies set up trusts to invest in Government Bonds when they find finance through competitive borrowing and through the equity markets?
And why do I , in my 60s, find my private savings defaulting into Government Bonds?
The answer is that we no longer have confidence in private sector equity or debt to pay our pension bills but must have the super security of the tax-payer behind us, just as we had when we contributed to SERPS through the national insurance system.
Lessons to be learned.
Many in Government did not think that the markets could turn on Government when it screwed up and jack up the cost of its borrowing as happened last year. They thought it might happen gradually but not at the rate it happened in late September and early October.
The regulators and the auditors and the actuaries and the lawyers fell in love with “risk free” investment in “long dated gilts” as this was the rational thing to do. Governments acted rationally, the markets reacted back – gilts were predictable, boring and sage – until they weren’t.
The LDI crisis has taught us that lending to Government can be reckoned by the market as risky as lending to companies- and then some. And one of the reasons the markets saw the Government as a “risky” borrower was the way that they allowed customers for certain types of debt (long dated and inflation linked gilts) to be concentrated in the 5700 DB pension schemes – almost all of which invested in these instruments and 60% of which jacked up their exposure to gilt yields using secondary banking (swaps and repos).
Synthetic SERPS
DB pensions have become a synthetic version of SERPS, reliant on gilts to fund pensions but only partially invested in gilts, relying on complex financial instruments to maintain exposures to assets that are still considered risk-free (at least in the text-books).
We are not talking small numbers here, UK funded pension liabilities run into trillions of pounds, at one point it has been estimated that there were more of those liabilities being backed by gilt than there were gilts in issuance (such was the capacity of secondary banking to issue synthetics).
We have actually ended up , where SERPS was planned to be, paying pensions backed by Government debt. But when the final reckoning is done and we work out how much it has cost the private sector to get to where it is today, we might ask – why it bothered.
We are used to asking questions as to why Britain in lagging in productivity, it’s failed DB pension system does not provide all the answers, but it is symptomatic of the failure of nerve by the private sector over the past 44 years. If we are to have workplace pensions, can we ensure that they invest in productive assets that strengthen Britain as an economic force , let insurers sort out what’s left.
