I am really pleased to see LCP getting behind the Mansion House reforms. Here’s what Steve Webb has to say in more detail
“Today’s announcement represents a huge leap forward in plans to allow well-funded DB schemes to invest for growth. Provided that member benefits are protected, schemes would be able to build up surplus funds, benefiting existing members, the next generation of pension savers and the sponsoring employer.
Rather than risk ‘wasting’ the potential of over £1 trillion of assets which have been painstakingly built up over decades, this new regime would be a win for members and sponsors alike.
And the announcement of a lower rate of tax on extracted surpluses is a clear sign that the Treasury is serious about these plans.
We look forward to seeing the consultation on the details of how this new regime will work and encourage all well-funded schemes to include the option of running on when deciding on their end game strategy”
Waking up to the reality of buy-out
What does Steve Webb mean by “wasting” assets? He is talking about their “potential” – a negative capability yet to be realised.
If we look back over the past two decades we have seen the primary objective of pension schemes to meet pension promises through liability driven investments. Investing to meet liabilities is the right thing to do , but there are more ways of doing it than through matching the duration of the liabilities to bonds (of any description). There are other ways, including trusting that long term assets will meet long-term return targets.
The reality of buying-out our pension liabilities with insurers is that we risk losing the “potential” and wasting assets that could work productively. Paying insurers to take assets of our hands in exchange for annuities is an expensive business, reckoned to command a premium of up to 20% of the assets. Much of this premium is associated with swapping potential returns from equities for the more certain returns of bonds, held for their full duration.
In 2022, the ONS estimate that £600bn was wiped off the collective balance sheet of UK corporate pensions. Much of this loss was paid to banks to keep hedges in place to protect schemes from interest and inflation rates falling. But much of the hedging was lost in the process and many assets that were sold will not be available to pay pensions in the years to come. The LDI crisis wasted much of the asset base pension schemes had built for the future.
Swapping those assets for annuities cuts off the potential to pay better pensions and reduces the opportunity for pension schemes to invest in gilts and productive finance.
LCP are saying that the remaining assets could work harder , not just to pay pensions for those in DB schemes, but to improve the pensions of workers who aren’t and improve the productivity and employment of thousands of companies whose activities have been cramped by pension regulation.
LCP are now talking about the opportunities from pensions, not the opportunity cost of having a pension scheme. This is a huge “leap forward” indeed. But it can’t be achieved without careful pension management. Pension schemes need consultancies like LCP as much as LCP needs to keep its pension scheme clients.
In addition, freeing up funds for employers and investing for growth would be of benefit to the wider UK economy, including helping to fund goals such as the transition to Net Zero.
China’s “great leap forward”
The only problem with this is that it is 18 years too late.
Should the Government not now be encouraging re-opening of DB benefit accrual?
Sadly, the reckless conservatism during the QE years has deprived pension schemes and employers of better return prospects over the long term. It has meant losses of £600billion in pension scheme assets, at least some of which would have been far better employed either by investing in a diversified portfolio of assets that have higher expected returns than gilts and can better meet pension liabilities (gilts do NOT match pension liabilities properly – they cannot meet the inflation (cpi/lpi/salary), duration, longevity risks, nor do they allow for the costs of scheme management or advisers. Capital asset pricing models are based on gilts being the lower expected return asset (of course QE intefered with that relationship since Bank of England buying made the gilt market operate as a market biased to lower rates) but the higher expected returns from a diversified pool of equities, small cap, early stage, infrastructure, alternative energy, real estate and other non-financial long-term assets, would have been expected to give much higher returns than gilts. Having LDI and swaps masked this risk premium argument, but the results were laid bare last year with the £600bn loss of asset value. Employers were forced to pay far more into their pension schemes than they would have needed to, meaning UK businesses had less capital to invest, employers then wanted to get rid of this balance sheet risk and sought the supposed safety of annuity buyout, which meant putting even more money into low expected return assets, just to match an estimate of liabilities. The asset value is real, the liability value is a guess at what the long-term costs will turn out to be, which ignores some of the risks that have materialised from a funding perspective. Investing DB schemes for higher expected returns would be a win-win and it is something I have been calling for but fell on deaf ears during QE years – now that QE has come to an end and QT is on the horizon, if not already with us, it seems that the case for moving into long-term higher return assets could help employers, members, the UK economy and the wider population – as long as more is invested in the UK itself of course! A brave Government woudl recognise the virtuous circle that could be created by directing pension fund assets into productive investments, instead of suposedly low-risk (ha ha) gilts which are chasing buyout and will then all be sold when an insurer takes them over, to add to pressure on long-term gilt yields from QT!!
I do hope we can move away at last from the flawed thinking that drove everyone to give up on using pension assets to boost growth and long-term returns.
The emperor’s new clothes.
Once an untruth is exposed, once the gullible realise they been aligned with a cult, all becomes clear and its impossible to live with the grotesque falsehood.
Credit to LCP, formerly a leading advocate of LDI, looking into the abyss they lifted their heads and have looked at the bigger picture, at last. Indeed, the only picture.
No economic system that is under-invested in productive assets, ideas and people can afford to pay for its social services including providing an agewage for its elderly. Its complete folly to think pensions can sit ‘safely’ out with a failing economy, and the baby-boomers attempt to construct a system that hypothecated a guaranteed reward to themselves while leveraging the systemic risk onto those that follow, was doomed to fail.
TPR induced and enforced de-risking (ie de-investing) has been a catastrophic failure in pension and investment policy – it will fail to deliver the promised pensions and it and is making our young folk very much poorer.
Of course the regulatory minded will continue to obfuscate, and to look for others to blame (“if only the Trustees were more professional and had implemented LDI better”), demanding stronger enforcement. But increasingly it will be difficult to ignore the unavoidable truth. You can’t save (in gilts) your way out of a depression, and you must invest (in business, people, education, ideas and innovation) to increase the productivity required to support an ageing population.