In this blog, I explain why offering guaranteed “pensions” is something institutional investors are interested in. There is an opportunity right now to reopen a proposition, all but forgotten – the defined benefit workplace pension.
To me, the most interesting finding that came out of the recent ONS report on DB dynamics is this .
Private sector defined benefit and hybrid pension scheme deficit reduction contributions, which have been smaller since Quarter 2 (Apr to June) 2022, fell to their lowest level in the published time series in Quarter 3 (July to Sept) 2023, which may suggest these pension schemes required fewer contributions to make up for funding level shortfalls.
Corporates have a pension budget that for years has been spent on keeping the DB pension afloat. These contributions were required because of QE which required DB schemes to consider them in deficit when in normal times they would have been in surplus. Now are “normal times” and schemes are in surplus despite giving up £166bn in assets to keep LDI hedges in place through 2022 and into 2023.
If , as seems likely, the surpluses currently enjoyed by DB schemes are maintained, then we can expect to see deficit contributions drying up and schemes looking to divert money that would have been paid to the DB plan- elsewhere.
The pension budget may not shrink, it may be reallocated to funding DC contributions and that may extend beyond contributions to the redistribution of surplus.
The impact on contribution rates to DC could be quite substantial and most unexpected. I doubt many master trusts have DB windfall payments baked into their business plans for 2024 and 2025.
We have for some time considered that DC de-risks DB. This is a trope, DC merely diverts risk from employer to saver. If savers want pensions they have to make do with annuities, which aren’t pensions but contracts of insurance that do the pension job- badly.
The original idea of a funded pension was based on trustees being able to rely on employers and employees to contribute to a fund that could take short term risk because in the long term, risks were rewarded. So long as DB schemes stay in their sweet spot, they work, as soon as they are closed for future accrual , they lose the infinite time horizon that make them work
The pension industry has got itself into a collective funk about future liabilities to a point that some trustees would rather take DB schemes into the PPF than run their schemes on. Outrageously, I have evidence of two DB schemes that has preferred to give their members a pensions haircut than run on.
But this state of funk is not shared by everyone, the private equity industry has woken up to the opportunity of backing DB schemes to stay open and I know of at two firms who are now offering capital to schemes who are in distress or looking to extract unwanted surplus to invest in the sponsor or boost DC pensions.
It is only a small step , for these confident investment decision makers to choose to open schemes up to take more risk. This is what is being proposed by Pension SuperHaven , a DB scheme that is opening to pay pensions in exchange for DC pots.
If the aim of such investors is to take risk, the structure used to manage the inflow of money is of little importance. Such activities can be governed by a trust set up by the investor but as easily use an existing occupational trust – including a master trust.
It is reasonable to think of Pension SuperHaven being embedded in any mature large pension scheme where there are likely to be flows from savers more comfortable with a pension than a pot. Infact , this seems the eminently sensible way for an investor to attract the “wanted”pension risk.
Once the risk is captured, it can be mitigated by selling on the unwanted risk, for instance longevity risk for which there is capacity in the reinsurance market. Investors are in a strong position to choose the risks they keep and the risks they choose not to keep.
Because investors like Carlyle and Disruptive Capital are looking to take on the mantel of the employers who set up DB schemes in the second half of the last century. This is understandable. Had those employers not lost their nerve, or in some cases not been talked into closing their DB plans, the occupational DB plan would not be considered broken.
We are so used to the concept of de-risking that we forget that there is an immense appetite for risk from the investment markets. So far, insurance companies have had the de-risking agenda to themselves , could this be changing?
Might now be time to rethink the DB/DC dynamic and recognise that by using collective structures, the individual saver can once again enjoy the defined benefits of a workplace pension scheme?