Paul Maynard, pensions minister, says the Government had “always intended” for Open DB plans to have “flexibility” and was “aware that this may not have been clear in the draft Regulations that were consulted on”.
— Josephine Cumbo (@JosephineCumbo) January 18, 2024
This is important, not just for schemes that are currently open, but for some schemes that may be thinking of re-opening. We don’t know the detail yet, but here is the clear policy intent from Paul Maynard, Pensions Minister.
Thanks to Jo Cumbo for the intelligence.
A clear intent
If the Government’s intention is to incentivise DB schemes to offer more pensions, this is the way to go about it.
It seems the Government are at last recognising what Baronesses Altmann and Bowles were telling them during the passing of the Pension Schemes Act 2021, namely that open schemes need to be given different treatment.
The different treatment will allow them to invest more in productive capital and less in non-productive and inappropriate liability matching assets.
Open schemes do not need to de-risk in the way that closed schemes do as is made clear by this excellent chart , produced by Derek Benstead. This should be printed and distributed to all case officers at TPR!
There will be a good deal of celebration over the next few weeks, if the DB funding code is published with this intent.
Another “Yes Minister” moment.
This is important. Following successful lobbying by some open schemes in 2020 (well done!) legislation was amended in 2021 to support a more investment led approach for Open schemes. And a good thing that was.
But, the truth of the matter is that ever since then DWP / TPR have been lobbing and scheming behind the schemes to close down that route – it totally fries their Statist brains to have an alternative mindset co-existing and thriving (how they must hate LGPS). And it is their very meddling to the 2021 legislation that has made the position so unclear it necessitates the intervention of the Minister to try and put DWP/TRP back in their box. As you have blogged before Henry, more evidence of the mandarins not really with the Govt / Ministerial direction on pension investment.
But equally important, there is no need whatso ever for all closed schemes to a de-risked approach so early in their life cycle. Its just an actuarial ‘convention’ to make their models easier to talk about to laymen. Actuaries use phrases like ‘modified duration’ for schemes (typically now 10 – 14 years) to represent the remaining life of the scheme. But again that is just an actuarial simplification to help selling of LDI hedging easier -the schemes (even in the simple diagram above) will be need to be part of an invested economy for some 40 – 60 years, and that is a very long time not to be invested, and as discussed many times before, the scale of these legacy DB schemes is now so enormous that if they all “de-risk” (ie dis-invest) they become part of TPR’s self-fulfilling prophecy as they strangle the very economy they expect to generate the tax revenues to pay the de-risked gilts.
I do welcome the suggested changes in respect of open DB Schemes suggested by the letter and do hope that this will encourage employers, and particularly smaller employers, to seriously consider re-opening DB schemes to benefit accrual. I do, however, think the whole ethos promoted by the DB code is fundamentally flawed and does not match the Government’s objectives to retain pensions schemes investing productive for the long term benefit of members and employers.
Not only does the Code suggest that Trustees should manage the Scheme against the most expensive outcome; but also by completely ignoring cash flows, following the Code itself increases the risk of Members’ benefit reductions in the future. What appears to have been ignored is that the actuarial valuation whether on a solvency basis or on a technical provisions basis reflecting employer’s covenant is a worse case risk measure and does not reflect the most likely outcome. Worse still managing a pension scheme against the Code ignores the most critical risks to the scheme which are not related to the approximated assumptions concerning the middle and long term future represented in an actuarial valuation.
This applies with even greater force to closed schemes where it is particularly important to manage the scheme against the most likely outcome with appropriate risk mitigation rather than worst case assumptions.
My specific observations:
1. Scheme maturity – a scheme becomes mature when cash outflows exceed cash inflows on a regular year by year basis. The cash inflows include dividend and interest payments, redemption proceeds from fixed term investments, employer and employee contributions, plus the net proceeds from investment sales of the capital assets of the scheme. The outflows include the pension payments, administration costs, transfer payments and cash lump sums, although the last two will result in lower cash requirements in future years. The key planning requirement is that the amount required to be realised from net capital asset sales does not result in future cash inflows falling faster than the cash outflows in those future years.
2. Market Values – Valuations and the Code are predicated by a comparison to the total market value at the valuation date. In reality changes to investment market values have a very limited impact on the financial health of an ongoing Scheme. Their only relevance is to the proportion of the capital assets of the Scheme which have to be sold in that year to meet the cash flow requirements. Dividends, interest, contributions and redemption proceeds are not changed by short term market value movements. 1 year Value at Risk measures are therefore fundamentally misleading.
3. Mortality – The fundamental issue in a closed ongoing scheme is will the capital assets run down at a faster rate than that required to sustain the cash required until the last member dies or leaves the scheme? The application in particularly smaller closed schemes of an assumption based on long term population metrics is likely to be misleading, particularly when those assumptions change. It would be far more prudent in the cash flow needs analysis to assume no deaths of current members until those deaths actually occur when the “scheme experience” effect should be reflected in full immediately and not just caught in the next valuation. Scheme experience gains in a pooled risk scheme will almost by definition exceed the life expectancy assumption (even a 97 year old pensioner will be assumed to live to at least 100).
4. Inflation – Valuation inflation assumptions are usually based on market determined measures of inflation over the expected duration of the liabilities. Where short term inflation measures differ from those assumptions the valuation becomes inappropriate – for example in a scheme with a RPI capped at 5% pension increase guaranteed benefit the unchallenged application of a 3.X% inflation assumption for the next year is likely to result in an underestimate of the effect not just in the year but also compound forward to all future years. A similar and probably more damaging effect applies when current inflation undershoots the long term assumption. Again this should not just wash out as a scheme experience adjustment at the next triennial valuation.
5. Discretionary Increases – in managing the Scheme, the Trustees should be prepared to justify why their forecasts do not reflect assumptions for discretionary increases provided for in the Scheme Rules. Where these have been custom and practice, that practice should be reflected in forecasts whether that should be in respect of early retirement enhancements (Boots) or in respect of pension increases (BP) and if necessary additional employer contributions should be requested to cover. The cash forecasts of the Scheme can also be used to indicate the capacity of the scheme within its existing resources to fund for discretionary increases provided in the Rules but which have not previously been granted (particularly where there is a specified objective for the discretionary power e.g. to provide full RPI indexation where a 5% or a 2.5% cap has been applied).
I do not see any attempt to fundamentally amend the basic premise of previous draft versions of the Code. Until this occurs the Code will be used by advisors and encourage Trustees to manage schemes to target the most expensive options of insurance company buy-outs and buy-ins and other risk transfer hedges with the consequent detrimental effects on scheme funding, members future benefits, and employer solvency. The Government if it is serious in wishing to ensure pension funds are invested productively for the benefit of members and scheme sponsors needs to ensure The Pension Regulator no longer acts as the recruiting sergeant for the insurance industry.
Agreed. All you say is eminently and obviously sensible and should be rounding adopted asap.
It’s a tragedy that so many wisest voices got / are getting drummed out of the sector by the Statist doing the work prepping schemes for the insurers….
We can but continue to be vocal in the hope and belief that wisdom truthfully told for the greater good, will prevail.