It’s de-risking that’s the elephant in the room

We have purged our schemes of risk – but at what cost to their health?

A  reader writes following my blog yesterday on LEBC’s demise

Would I be mistaken for thinking that ‘de risking’ as promoted relentlessly by the consultants and advisers – at an eventual cost of £550 billion is the real elephant in the room?

De-risking comes in many forms. It includes longevity swaps, which swap the risk of people living too long for a cut of a pension scheme’s assets, the enhanced transfer value, where the trustees pay over the odds to say goodbye to potential pensioners, the PIE (pension increase exchange) where people sell their rights to an inflation linked pension for jam today.

All are designed to take risk off the corporate balance sheet at the expense of member’s future benefits. A recent study by William McGrath’s C-Suite has shown that longevity swaps have worked overwhelmingly in the favor of those issuing the bonds (mainly because of mis-pricing), CETVs and ETVs have decimated our advisory capacity (latest victim LEBC) while the Pension Increase Exchange – which seemed so harmless to member’s interests when inflation wasn’t a thing – has now left a raft of pensioners stuck with the nominal pensions of today, with no inflation protection at all.

Then there’s the big daddy of them all, LDI. Like all the other de-risking exercises, LDI has turned against those it sought to protect, being responsible for most of the £550bn fall in the asset based of corporate DB plans in 2022.

We can point to three reasons why de-risking was so popular

  1. It played to the worst instincts of actuaries put assumptions ahead of common sense
  2. It played on the short termism of pensioners , sponsors and regulators (jam today)
  3. It was massively fee-generative – at the expense of the future security of members.

Assumptions ahead of common sense.

The tacit assumptions that over time – that long-term assets would pay pensions held true for the second half of the twentieth century, allowing pensions to build immense wealth and influence.  Pensions became the funders of much of the growth in the UK economy  and pensioners reaped the rewards. Sadly sometime the rewards were over-extended and promises were made that turned best endeavours into cold guarantees. The massive amounts of risk taken on when schemes started guaranteeing inflation protection at the end of last century created a vulnerability within pension scheme funding.

With this vulnerability in min, a new industry took hold, which set out to take out the risk from pension schemes, no sooner than it had been taken on. Instead of valuing pensions on the assumption that investments would lead to growth in assets, pensions were valued on firesale of “marked to market ” valuations which led to a balance sheet crunch.

All of a sudden, the talk was of pension schemes not being “affordable” and the new way of accounting for their solvency saw a radical change in investment. Rather than assuming a single discount rate based on the long-term assumptions of scheme asset growth, valuations were based on the gilt yield and the tyranny of the gilts + discount rate began.

Once the assumption that gilts represented the “risk free return” on pension assets (the liability match) de-risking was born. This is what I mean by “putting assumptions ahead of common sense”. Anyone working out what they can pay themselves from their DC pension pot, starts with a consideration of how the pot will grow, not what an annuity would pay. Everyone that is, than a DB actuary!

Jam today

For a decade we have been taught that living too long is not a problem. We have been weaned off a fear of the corrosive impact of inflation and it’s been implied that the state will take care of us – when we can’t.

So we have been sold pension freedom, freedom from having to insure against old age through pensions, freedom to draw money from a pot created by a CETV, enhanced by an ETV or supplemented by a PIE. We have swapped prudence for swollen bank balances.

These “exercises” were little more than a play on the behavioural instincts of the ill-informed who chose jam today rather than security tomorrow.


Fee larceny

These “exercises” amount to a collective act of mis-selling by the pensions de-risking industry which has been recognised by the FCA (hence LEBC) but which is shamefully ignored by the Pensions Regulator. Indeed , many of the senior figures from TPR’s management in the past 20 years now hold senior positions in schemes and advisory firms which have been the architects of pension de-risking exercises- most notably LDI but also the value destroying Regulatory Apportionment Agreements which led to members having to choose between benefit haircuts from their scheme or the PPF. Witness BSPS.

Ultimately, the bills were paid for by Trustees or out of money that would otherwise have been paid by sponsors to trustees. Schemes paid others to take away the liabilities they were set up to meet. And the money paid out over the years of quantitative easing was based on the crazy assumption that the cost of the benefit could be measured by the QE depressed gilt rate.

The cost of de-risking wasn’t just the fee larceny of the exercises but the payments made to former members which denuded the fund for no good reason. The people who have been tempted away from pension schemes were celebrated in the board room only a couple of years ago. Today their reduced liabilities would be reckoned as part of a surplus.

As mortality projections continue to fall, we are waking up to the harsh reality that we are not getting healthier and with the impact of climate change to come, we may never achieve the projected longevity we boasted about five years ago.

The constant meddling with defined pension schemes is the result of advisers and trustees needing to show they have a strategy that assumes the worst case. The impact of losing a sponsor, of ongoing recession and of market dislocation. Value at Risk has become the key strategic measure which has fostered the cult of de-risking .

Now, the schemes that feared for their future, find they are in a “surprise” surplus. The only thing “surprising” about their surplus is how small it is – relative to the cost to sponsors of meeting the bills over the past twenty years.

De-risking really is the elephant in the room

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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9 Responses to It’s de-risking that’s the elephant in the room

  1. Allan Martin says:

    I don’t want to enter any LDI debate that doesn’t start with quantitative easing (QE) but on the subject of pension scheme risk management can I re-iterate two points –

    History; (1) Ted Heath, refunds of contributions, (2) Barbara Castle, GMPs and deferred revaluation e.g. 8.5% pa…(3) Norman Fowler (?) anti-franking, (4) John Major 1986-91 non-GMP revaluation, (5) 1995 Pensions Act compulsory pension increases, TMT Boom and bust, Malcolm Wickes 10th May 2003 wind up liability, FCS/PPF, Lehmans, QE, no QT, ….society demands some backing to these deferred pay promises and a balance of investment risk and reward.

    Arithmetic; Deferred pay payment = mortgage repayment? My building society wasn’t impressed with my suggestion of trebling my mortgage, investing 2/3rds in equities, assuming an extra equity return of 3-4% pa and halving the monthly repayment over a shorter repayment period!

    PS. The Bank of England Pension Scheme Accounts 2022-23 may extend the investment risk and reward debate.

    • byronmckeeby says:

      Can you clarify, please?

      1. Are you suggesting QE created a favourable climate for LDI? For LLDI too?

      2. I believe the critical date introduced by Malcolm Wicks was 11 June 2003, not 10 May.

      3. Your rejected mortgage strategy seems to be a form of leveraged equity investment, LEI as opposed to LLDI?

      4. The 2022 Bank of England scheme accounts were signed off in September last year. They included references to the latest triennial funding valuation as at 29 February 2020. While I agree that if the 2023 accounts are signed off next month they will shed some light on what has happened to asset values in the intervening period, do you really expect the latest triennial valuation as at 28 February 2023 to be signed off by then as well?

  2. PensionsOldie says:

    Well said Henry!

    I believe Members have been forgotten in all this..

    The fundamental of Trust law is that the assets of a trust are held exclusively for the beneficiaries and the trustees duty is to use those assets solely for that purpose. Are Trustees of a pension scheme fulfilling their responsibilities if they remove the beneficiaries claim on those assets by transferring the risk to their pensions to an insurance company by buy out only to gift the residual assets back to the sponsor?

    In most cases the Members contributed to those assets as well as the employer. The employers contribution was also seen as providing a deferred salary for the then current service.

    In the situation with a pension scheme currently being assessed as having sufficient assets to pay the promised benefits on a self-sufficiency run out basis and retaining a residual claim on the scheme sponsor and the possibility, however remote; that surplus assets can be used to enhance benefits e.g. to disapply past or future inflation caps, is it really in the Members’ interests to transfer the risk to an insurance company on a fixed basis?

    The risk to the Member is not removed by the transfer to an insurer. As well as the relative risk to the real value of the pensions; there is always the, hopefully remote, risk of the insurance company failing to meet its obligations (Equitable Life). Surely that remote risk is being increased by the insurance company taking on the same future pension payment obligations with a substantially reduced premium over that which would have been paid a year or more ago! This is surely a foreseeable risk that has to be considered against the alternatives.

    For possibly separate reasons, the Government and DWP are seeking to make insurance company buy-out as the destination of last resort on the journey plan of the remaining 5,000 or so DB pension schemes. The Mansion House Speech proposals seek to promote scheme run on for larger schemes and consolidation for smaller schemes over buy-out. Surely the most effective and lowest cost way of achieving these goals is to give the Trustees confidence that Members benefits are not being put at risk will be to raise PPF protection levels to 100% of scheme benefits.

  3. John Mather says:

    “Surely the most effective and lowest cost way of achieving these goals is to give the Trustees confidence that Members benefits are not being put at risk will be to raise PPF protection levels to 100% of scheme benefits”.

    Who pays this underwriting cost? Surely this could only work by making the tax-payer the ultimate guarantor.

    • PensionsOldie says:

      The tax payer is likely to be the ultimate guarantor whether the benefits remain in the pension schemes protected by the PPF or whether they are transferred to the insurance companies protected by the FSCS.
      What is the greater risk to the tax payer – sufficient of the 5000 pension schemes failing to require the funded PPF to require Government support or sufficient of the small number of insurance companies active in the buy-out market to overwhelm the entirely levy funded FSCS?
      In either case the triggering event is likely to be a systemic risk common to both.

      • jnamdoc says:

        Current model is doubling up on systemic risk.
        Best defence against systemic risk – diversify, avoid herd mentality.
        Change remit of and reduce powers of TPR.

  4. jonspainwp says:

    Using the discount process with a single discount rate (or split rates across retirement age) was a huge driver of the problem. not just where it was pitched. One “value” of the liabilities is utterly unable to reflect the volatility that WILL be experienced. Indeed, the liabilities are truly the series of future benefits cash flows, rather than a singly number purporting to represent those cash flows. Not only can the typical assumptions not be shown to be prudent (without identifying best estimate) but also illiquidity is invisible. Happy to chat, more on (being updated soon).

    • emigreeu says:

      In your blog you mention £400 bn of contributions over 13 years. Does this mean that 15+ years of contributions has been wiped out by LDI?

      • jonspainwp says:

        Thanks for suggesting an interesting way of looking at it, I agree except that LDI has cost something like £550 b, also eliminating earlier years’ contributions (normal plus special), that worked out well, didn’t it?

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