a “uniquely horrible” brew – according to the FT’s Jonathan Eley.
In the final years of the last millenium, defined benefit pension schemes were described by Frank Field, then a Government Minister as “Britain’s great economic miracle”. A quarter of a century later they are described in an FT headline as “uniquely horrible for UK plc.”
This fall from grace can be traced back not to a fraud by Robert Maxwell which undermined the confidence shared before then by most people, that defined benefit pensions resulted from the best endeavours of companies to do the right thing for their staff by deferring their pay till they needed money but had no means to earn it. Money paid into defined benefit schemes not only benefited staff , but benefited the nation, as it was used to finance the growth of UK plc.
Once Maxwell had shown that a pension scheme could be used (fraudulently) to fund the company that supported it – at the member’s expense, the public were given to believe that this fraud represented a systemic risk that pensions wouldn’t be paid.
From here it was a simple step to legislate that pensions be guaranteed in payment, a move that was politically popular but economically disastrous as it led to a new way of valuing pensions, not on the basis of what could go right, but on what could go wrong.
Pension schemes had to ask themselves what would happen if the worst came to the worst and the pension scheme had no future contributions. Would the pension scheme be able to support itself on what it had and was what it had presenting a risk to the sponsoring employer.
These questions were planted in the early iterations of what we now look forward to – the Pension Regulator’s DB funding code and the DWP’s funding regulations.
The enterprise value of defined benefit pensions in the last century has been turned upside down. Jonathan Eley’s article in the FT tells us
Schemes have held back wage growth, distorted decision-making and consumed incalculable amounts of management time
He is of course right, and they will absorb yet more money that could have been paid in wages , invested in research and development till liabilities are sold to insurers and the horrible problem is got rid.
Too late, defined benefit schemes are waking up to this. The consultation on the DB funding code which closed this week is only the latest page in a book opened in 2019 which explains how the Government intends to fast-track the vast majority of DB schemes to buy-out by excluding them from the oxygen of growth and smothering them in “matching assets”, low growth debt that is acceptable to insurers but denies once prosperous pensions the opportunity to even pay existing pensions (let alone accrue new pension rights).
This sad state of affairs is the direct result of a mentality that plans for the worst rather than striving for the best. While politicians have spoken on platforms about renewing Britain, they have accepted the received wisdom of financial economists that value at risk is the critical measure. It is like going in at half time 1-0 up and coming out for the second half without a single forward.
After a decade of sitting on the fence, the USS – Britain’s largest privately funded DB plan, has shared a letter it wrote to the Pensions Regulator in which we are told it says it has deep misgivings about the proposals for the new funding code.
But it is too late to have such misgivings now. The funding code is only the formalisation of policy that has led to pension schemes losing over £500bn through over exposure to supposedly “low-risk” assets and in the process putting in peril the financing mechanism for the Treasury.
The USS has relentlessly towed the party line , requiring supposed deficits to be reduced by cutting future pensions and increasing contribution rates for employers and members. Those who have stood out against this craven capitulation to the mantra of “de-risking” have found themselves ostracised and excluded. The USS is saying now , what it could and should have said for the last fifteen year. It says these things now because it is solvent under the very regulations that it has clung to as it created the value destruction it accuses the Government of pursuing today.
This is the end-game of what started with Maxwell. The steady sorry decline in confidence has now led us to a point where pension schemes are being blamed for not just emperilling gilts, but denuding Britain of the investment it once enjoyed.
Meanwhile, we look likely to want to exchange the once great economic miracle for annuities paid by insurers and backed by yet more debt. There is no turning back from this.
For those who have saved for a retirement there is hope, if we can only abandon the worst case scenario and plan with optimism, we can have a pension system to be proud of – again.
Our task now is to rid this pernicious thinking from the DC pensions we are creating. The big ideas for doing that depend on embracing the enterprise culture that inspired companies to set up DB schemes after the war. I see no such culture in place in corporate boardrooms, in which case we must look to build it ourselves. Changes of the kind called for by USS originate from the views of those for whom pensions are too hard to organise themselves. We need a new mutuality and any organisation which is prepared to enable individuals to join together to turn personal post into collective pensions, is worthy of admiration.
Well said.
We ignored a key finding of the Myner’s review that actuaries were not well placed to give investment advice – the solution foisted upon us by the “industry” (through cosy chats and backdoor lobbying) was to eliminate investing. Instead we stood back and allowed them to dream up the LDI model which requires no actual investment expertise. Govt accepted this, and became complicit, as the model funnelled funds to the Treasury at a time and at prices no sensible investor would buy them (ref the “idiot premium” previously referenced in this blog).
We are now in an even more ridiculous situation, as a Nation, of rushing to the cliff to hand over well funded schemes to a handful of institutions, with a huge chunk of profit in-built, and who will on large invest in a pile of low aspiration gilts.
If you can understand “endgame” as mass confiscation, under which scheme surpluses (which could/should be used to protect members against inflation etc) are converted to insurers’ profit (and for taking very little risk i.e. no investment) you can start to see who the actual beneficiaries of this system are? And its not the sponsors or the members!
If one was trying to denude a nation of investment and growth, inevitably leading to a real crash in gilts (not the dress-rehearsal witness last autumn), we are going about it the right way. The question is when, not if.
Hopefully, and these blogs play an important part in the debate, the folly of dis-investing on such an enormous macro-economic scale will become overwhelming self-evident to all other than the most myopic or selfish.
Pension schemes need to “invest” for their own and the common good – that is why they have a tax favoured regime.
LDI salesmen…
https://www.bing.com/videos/search?&q=That%27s+My+Quant+The+Big+Short&FORM=VDMHRS
Henry and Jnamdoc, as so often your commentary is spot on. I thought you may like to see my funding code response which I summaised on linked In on Friday and set out below:
“Comment on TPR’s DB Funding Code Consultation (Deadline today 24/3/23).
The Consultation encourages responses via the online form. However, there is only the opportunity to answer or comment on the predetermined questions which go into the detail of the DB Funding Code. TPR should be congratulated on the detail, clearly enormous effort has gone into producing the code.
There is not an opportunity to express views that are not aligned with the set questions. So, thought a LinkedIn post to make my observations would be a good idea.
1. The code is very difficult to read and comprehend, not because of a lack of understanding of how funding works, but because the code and consultation goes round in circles trying to define the undefinable, i.e. future risk.
2. The code is an admirable attempt to codify the actuarial valuation process, but in doing so is taking a very restrictive set of risk measures which effectively tie the Scheme Actuary and Trustees up in a mass of impenetrable “RED TAPE” forcing Trustees to make statements on “risk” and “risk taking” that can never be seen to be correct with the benefit of future hindsight, exposing Trustees to future claims of mismanagement.
3. Current DWP/TPR policy on DB funding is directly encouraging “risk transfer” to underwriters who will profit at the expense of Sponsor shareholders and scheme members and will hasten the destruction private sector DB provision.
4. The code will reinforce the misallocation of capital to non-productive gilts at precisely the time when the UK needs to invest heavily in climate change reduction infrastructure. In short diametrically opposed to current government policy and ambitions.
5. The funding code will hasten the wish for Trustees and Sponsors to cease DB provision, however at present there is only one “approved “consolidator which in reality is just a bridge to Insurance buy out. TPR have not considered the systemic risk this places on the UK financial system, particularly as the Insurers offset their risk with overseas 3rd parties i.e. the reinsurers.
6. In short despite the heroic effort put in by DWP & TPR to codify the valuation process there does need to be a radical rethink of policy.
7. I hope the recent LDI crisis will give DWP pause to reconsider its current path, good policy should be set on guiding principles that don’t make delivery of members pensions unbelievably complex.
Does anyone else think the same?”
Bob. you pull off a neat trick of damning the Code without damning its authors and for that much praise. There are no vilains here,only people doing the wrong job, as Jnamdoc points out. Without David Fairs . there is no one to fight the Code’s corner. It looks punch-drunk after going 15 rounds against common sense, who – though it can be floored sy sophistry, will always prevail in the end.
I Hope so henry. However common sense is often unavailable to the indoctrinated, even when it is there in plain sight!