Are pension funding levels just too good to be true?

Edi Truell’s question is one that this blog has been asking for a while now. When Dr Iain Clacher quoted a figure of £500bn as the loss incurred by UK pension schemes from interest rate rises at the Work and Pensions Committee , he was accused of exaggeration. The ONS numbers on workplace pensions not only prove him and Con Keating right, but suggest that they might have been under-estimating the scale of loss. The losses to those who have crystallised their DC pension pots over the past twelve moths add to the economic and financial catastrophy. For a detailed analysis of where the money has gone, read yesterday’s blog.

This blog cannot answer Edi Truell’s question. I do not think there is an answer as to how  the pensions industry convinced itself it was a good idea to use the Repo and Swaps market to borrow a glut of gilts to satisfy regulators that schemes were or would be solvent.

But evidence that the industry still believes it did de-risk pensions can be found in the Telegraph article that Edi links to. Steve Webb argues that the funding position of UK pension schemes almost justifies the losses they have incurred. This of course assumes that were interest rates to revert to previous low levels, the £550bn would re-emerge like the lost village when a drought lowers the water level behind a dam.

No – the £550bn has disappeared, it is not going to be magicked back by LDI funds that have retained their hedges (and are now demanding financially unsustainable buffers). And it certainly isn’t going to reappear for schemes that have lost all or part of their hedge.

Pension schemes now run a quite different risk, the risk that there will not be sufficient cash within the scheme, to meet pension payments, unless they find a willing buyer for their assets and liabilities.

The worry is as much about the assets as the liabilities.

We know more about liabilities than we have ever known before, largely because of the increased focus on mortality and morbidity , over the pandemic, partly because we now have ways of capturing data that allow us to see thing not just as they are , but as they are likely to be.The story on liabilities is that they are likely to be lower than estimated. This is good news if you are funding your pension and bad news if your are a current or future pensioner.

We should be less worried about liabilities and more worried about assets  and not just the remaining assets in the leveraged LDI programmes. Many DB pension schemes, and an increasing number of DC pension schemes have used the opportunities of free cashflow from leveraging gilts, to invest in illiquids which are currently looking to have returned remarkable results relative to other assets in DB portfolios.

The valuation of such illiquids is problematic. Many of the valuations are untested which is why insurers looking to buy out pensions are reluctant to take them on at book value offering a markdown of up to 40% of the state valuation. The correct way . unless you are being very honest with yourself, to get your illiquids valued, is to buy them in a quoted vehicles, such as an investment trust, where the assets you hold are valued by the market at the price people are actually paying for them.

If DB schemes are relying on untested valuations of illiquid assets to meet future pension obligations then the Pensions Regulator should be concerned. So should members. The depletion of the asset base resulting from the rise in interest rates last year leaves some DB pension schemes very vulnerable to any nasty surprises.  If such schemes were willing to follow the herd into leveraged LDI policies, what reason have we for thinking they are not doing the same when it comes to investment into private illiquid markets – with the potential for the same consequences?

I would rather take my lead from Edi Truell who ensured that in 2013-14 , public sector pension schemes stayed clear of leveraged LDI , than consultants whose clients by and large didn’t. Arguments that you have to stay in gilts and in leveraged gilt portfolios whatever the prognosis for interest rates, are based on ideology not reality.

The laws of common sense that state that if things look too good to be true, they probably are too good to be true – apply as much to pension scheme funding levels as anything else.


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in pensions and tagged , , . Bookmark the permalink.

6 Responses to Are pension funding levels just too good to be true?

  1. John Mather says:

    Who is to give the advice?
    Which Regulator do they work under?
    Who pays for compensation for defective advice?
    Who benefits from fines
    The Victim
    The victim’s pension pot
    The Regulator
    The Treasury

    March 26, 2023 at 7.32
    Could have made it clearer in this case.
    If so much attention was given to BS then when will we get
    a report on LDI?

  2. Con Keating says:

    There has already been one report from the Lords Industry and Regulators’ committee.
    The Work and Pensions Committee report is yet to come

  3. Con Keating says:

    Steve Webb’s argument that the improved funding ratios justify the losses is highly suspect. It ignores the fact that some £100 billion of those losses were tax concession based and will not be recovered. It could only be recovered if we were to make the next £545 billion of asset improvement taxable, something I certainly would not advocate. It also assumes that the discount rates now being applied prove to be real which is almost impossible. If schemes had been completely invested in gilts those discount rates would have been assured but they weren’t. In fact schemes own just £126 billion of conventional gilts. Interest rate swaps can’t be expected to save the day either, recouping the £41 billion lost there will not come close. Then we need to think about the high yielding assets sold – a net £18 billion of corporate bonds have been sold and much more. I regret to say that it seems highly likely that the highly vaunted improvements in funding ratios will prove illusory.

  4. John Stanley Mather says:

    So no one is responsible!!!
    Doesn’t give comfort to trusting collective funds with
    Individuals benefits

  5. Chris Giles says:

    And they were too bad to be true in the past!

    It’s time to ditch the discount process and replace it with a funding system based on cashflow management. We need to build a framework that recognises the stability provided by long term predictable income streams and not the volatility resulting from short term changes in the market value of assets.

  6. Chris Giles says:

    The UK gilt market had been in an asset bubble, supported by DB pension funds and the Bank of England, for more than a decade. The Government (along with The Pensions Regulator) have been in denial over the impact that the loss of the UK’s ‘AAA’ credit rating has had on global bond investors – there are now more than 20 countries with a higher rating than the UK!

Leave a Reply