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
- It played to the worst instincts of actuaries put assumptions ahead of common sense
- It played on the short termism of pensioners , sponsors and regulators (jam today)
- 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
