Could DC consolidation cause a fresh pension crisis?



In this blog I argue that DC has its own version of LDI which is still embedded in many occupational DC schemes. Transferring out of these schemes risks crystallising losses for savers – akin to “losing the LDI hedge”

When I read the PLSA’s update on my retirement living standards, I was struck by the precision of the calculation of retirement living standards , but the lack of detail about the cost of meeting them – certainly from private resources.

In theory , the cost of converting a pot into a pension should be in equilibrium. You should (in theory) invest in funds prior to the conversion in funds that perform in a contrary way to the cost of purchase, this is known as a hedge and it’s what the theory of Liability Driven Investment is all about.

So if the cost of buying an annuity rises by 30%, the value of your pre annuity purchase fund increases by 30% (no problem). But if the cost of buying an annuity falls by 30%, are you happy to see your pot shrink by 30%?

I think the answer to that is very different if it’s your money or other people’s money, that you are talking about. I know many pension scheme trustees who say that it doesn’t matter that their fund has lost 30% of its value because it is now solvent – the cost of buying a bulk annuity may have fallen by 30% or more. But I know nobody who is in a lifestyle fund that invests in bonds because that is the “risk free” thing to do, who is happy to have seen their pot shrink by 30%, especially if they know they could have been invested in cash or some growth funds, where capital has been preserved.

September 2021 – September 2022 performance numbers.

If you had been planning to buy an annuity in September 2022 , then your Pre-Annuity Plan might have bought you the same annuity as a year before. But you would have been able to buy 38% more annuity if you’d been in the Preserve Plan. Would you be happy or pissed off?

Have fiduciaries got a case to answer?

It has been reported in the trade press that a number of law firms are gearing up to take legal action about leveraged LDI.

There have been no reports about trustees , or workplace scheme funders taking action against the managers of these DC LDI funds. Nor have I heard of any members of a DC pension taking action against trustees for running a default that targeted annuities without asking them or their intentions at retirement.

Nor have I heard of anyone taking action against an adviser for allowing their pension pot to be invested in such funds through the year from September 2021.

Nor have I seen a red flag being thrown against a DC pot transferred from a pre-annuity plan in the third quarter of 2022.

There will be people who advisedly or non-advisedly, moved out of such funds since September. They will have lost their LDI hedge in return for what?

This fund is taken as an example of a pre-retirement fund -not an Aegon default strategy.

Happily,  most default strategies that de-risked from equities to bonds/gilts have now seen the pot grow a little since the nadir in Sept/Oct – annuity rates have fallen too, but if you’d sold ( or been sold out of) this fund in September , you would have missed the bond bounce since.

You’d have crystallised at least a 30% loss on your funds and have no exposure to the hedge against interest rates rising, which was why you were in the fund in the first place.

So what of members tied to the stake of LDI style default strategies?

In theory trustees and scheme funders have no case to answer, they were doing their best and had imperfect information on their member’s intentions. The Pension Regulator is now reminding fiduciaries that they ought to know what their members intentions at retirement – especially those close enough to retirement to be in a de-risking lifestyle program.

Most trustees and funders will be able to demonstrate that they have changed their default in line with information they’ve gleaned from staff or perhaps more commonly available information such as the survey by the FCA on how people are taking their retirement income.

Those that have not adjusted lifestyling will be vulnerable, especially where there is no clear statement of why a bond/gilt strategy was suitable for the default investment fund of a workplace pension. I suspect that the problem is confined to older schemes which have less attention paid to them. Many DC occupational schemes have closed to future contributions and have low governance budgets.

What information do we have?

We now know that 1800 DB pension schemes used pooled funds to get leverages exposure to long dated bonds and index linked gilts. The Government Actuary has identified the problem from leveraged LDI not with the schemes that retained leverage by meeting collateral calls, but with the schemes that didn’t. The information that TPR gathered in 2019 for its stress test was not from schemes with pooled funds but from larger schemes who had bespoke LDI programs. Small schemes went under the radar – but nearly blew up the bond market.

There is a parallel in for the DC LDI problem and TPR is on it. The large workplace pension schemes were onto the problem, made adjustments and those invested in pre-annuity funds had generally chosen to be there.

But, as with DB schemes, the problem may be with the schemes TPR don’t know about, schemes that may be so badly governed that they don’t know they have a problem. Such is the inertia with which ordinary savers manage their pensions that billions are likely to be tied up in such plans.

The risks in these plans

I hope that no funder or trustee panicked last autumn and sold their lifestyle plans out of gilts and bonds, that would be the equivalent of deliberately “losing the hedge” – something that my be the cause of litigation in DB-land and possibly the reason for a class action in DC-land.;

I think it unlikely that many (if any) class actions against DC funders and trustees will be organised because it is hard to mobilise a group of members. But the risk remains.

The risk for DC schemes of maintaining LDI style defaults is not so acute as in DB (where clearly fingers are being pointed). The risk for DC workplace pensions is reputational. If those who manage other people’s money are not taking due care then they are failing in fiduciary/consumer duty. Maintaining the strategy (as Martin Clarke advises DB schemes to do) is likely to be less harmful than scrapping LDI.

The Government’s strategy is for DC schemes which offer poor value for money to consolidate. Ironically, if members of a poor DC scheme are currently de-risked into a strategy based on gilts/bonds, consolidation could trigger the loss of the LDI hedge and crystallise 30% losses. Consolidators beware!

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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