From bail-out to buy-out.

Six months on from a major risk event triggered by a “de-risking” strategy , employed by the vast majority of UK’s corporate pensions, we are being asked to celebrate the impending buy-out of what’s left of scheme assets because liabilities are notionally a lot cheaper.

Should Britain be trusting it’s trillion pound company pension legacy to a handful of insurers when funds are badly needed to grow the economy?

This is a  question I heard being asked from number 11 Downing Street to the boardrooms of some of our most exciting and innovative companies.  It was being asked in the House of Lords as the Pension Schemes Bill was being read, I sense it is behind TPR’s announcement last week that it is delaying the implementation of its controversial funding code.

Taking risk off the table may sound good to an FD sick of relentless cash calls  and restrictions on corporate activity from pension trustees.

But if the price for this is the non-availability of equity finance to the next generation of UK growth stocks and a workforce that finds the drawbridge pulled up against their accruing proper pensions, is it a price worth paying?

I read in the FT the baleful story of Immunocore

Immunocore is a success story for the UK’s ambitions in biotechnology. Spun out of Oxford university in 1999, it is pioneering a new generation of medicines to treat cancers, viral infections and autoimmune diseases from the leafy market town of Abingdon-on-Thames.

But for Sir John Bell, the Canadian-British chair of the company and one of the world’s leading immunologists, its story stands out for a less distinguished reason.

“Immunocore is, I fear, a classic example of what the UK has been losing,”

In its early days, Immunocore attracted some backing from domestic investors. But three later funding rounds failed to secure any more UK money. When it grew large enough to list on the stock market in 2021, it shunned London in favour of Nasdaq, where its market capitalisation now stands at $2.6bn.

“We have a massive upfront commitment to the sciences in the UK, then all the commercial benefits go to investors elsewhere,”

says Bell, who is also regius professor of medicine at Oxford.

“There wasn’t really any access to long-term scale-up capital in the UK ecosystem, UK venture capitalists didn’t have pockets deep enough and domestic pension plans had no interest because they are too conservative to invest in the growth sector”.

The result, as he puts it, is that

“the most successful British biotech company is now really plugged into the American capital markets”.

Every corporate pension scheme that is bought out by an insurance company is another source of finance to the next generation of Immunocores. We celebrate PIC, Rothesay, L&G , Aviva, Phoenix,  Scottish Widows , Just and Canada Life buying in or buying out pension benefits with little regard to what is lost. What is lost each time this happens is another source of productive finance that could be investing in growing the economy.

In so doing ,we are denying our children and their children the opportunity to participate both in the vibrant economies that they see in other developed countries and the long-term security that our pension system is securing their previous generations.

The introduction of FRS17 in 2000 followed by its adoption in 2004 by pension schemes as the means by which they accounted for deficits and surpluses,

Michael Tory, co-founder of investment banking boutique Ondra Partners, argues that defined-benefit schemes should be decoupled from their corporate sponsors and consolidated into a handful of superfunds.

“The corporate link has severely distorted UK pension funds’ asset allocation — making it accounting rather than investment performance driven — and it has also depressed pension fund returns. Decoupling would free them to reorient towards long-term performance, more professional management and scale from consolidation like in other countries, for example, the transition now under way in Holland.”

Many people have a perception of such superfunds as the plaything of hedge-funds and venture capitalists. It is true that much of the drive to create such structures has come from Edi Truell, who many in pensions regards as a “barbarian at the gate“. But without having such people within the pension fold, it is hard to see where an alternative to the relentless capitulation to insurance is going to come from.

Is this really in the best interest of the consumer?

I am quoted in “this is money” this weekend , expressing my disquiet as the buy-out of the fittest culture that is emerging,

Insurers take over defined benefit pension schemes to make a profit. The more surplus assets that a scheme has to meet future liabilities from members drawing an income, the more likely it is to be snapped up by an insurer. Henry Tapper, founder of pension firm AgeWage, says: ‘Where an employer’s capacity to meet further cash-calls from pension trustees is compromised, a buy-out by an insurer is likely to be good news.

‘But sadly, weakly sponsored schemes are usually weakly funded and in a buyer’s market, weak schemes are unlikely to get bought out.’

Tapper is also worried about the ‘concentration risk’ caused by such a small pool of insurers prepared to take on the liabilities of pension schemes. He warns: ‘A failure of just one of these insurers could wreak far more damage than Maxwell or Equitable Life ever did.’

Alarmist? I don’t think I am any more alarmist than those on the other side of the argument that argue that

The member will no longer need to worry about the sponsoring employer’s financial health

The sponsoring employer’s financial health has been sorely tested for decades by the relentless desire for “prudence” from trustees and Regulator. That prudence is now being given to insurers at a knock-down price ensuring that our children’s employers are working for overseas shareholders who have no interest in their financial futures, especially their retirement planning. The prudence that could have gone to protecting members from inflation is instead providing bumper profits for shareholders of the insurers involved.

Meanwhile, the weakest pension schemes with the weakest sponsors are required to soldier on, typically denuded of assets sold to meet the cash-calls of those they borrowed money from to gear up on debt.

The alternative approach, one that the Pensions Regulator appears unable to stomach, is to permit DB schemes to re-risk, either by abandoning TPR’s fast track proposals or joining a superfund investing for the future , rather than feeding the maw of our pension system. I would like to say that these choice are available but currently they are not. The DB funding code, while in the weed, is still emitting risk warnings while the superfunds are grounded awaiting a change in Government thinking on the practical ways of delivering productive finance from pension schemes.

Is this any way to run our pension system? If there is a backlash against buy-out , it cannot come a moment too soon. The Pensions Regulator has again delayed the implementation of its DB funding code, let us hope that it is now too deep in the weeds to make another reappearance and let’s hope that in its place we get an approach to funding that encourages schemes to stay open and invest in Britain.

As Nigel Wilson, outgoing CEO of L&G tells the FT

“We shouldn’t give up on DB because the average duration is still 15 years,”

Let’s hope that once he’s left L&G , he can explain what this means in practice.

Meanwhile, Keith Ambachtsheer sums up the mood of those wishing to put a break on the surge to buy-out.

“It takes a long time to do these transitions; you can’t just turn a switch,….. but if you don’t start, it never happens.”