In this article, I refer to some recent analysis by Kempen of the opportunity opening for DB schemes to create surplus, if current gilt yields remain. I support the analysis, though I lament the opportunity cost of a wasted decade when pension schemes invested in instruments with negative real returns
I was drawn to Kempen’s analysis of alternatives to buy-out by its comparison of a capital backed journey plans with Superfunds.
Because Clara is the only superfund , it is what superfunds have come to be. It is a sorry state of affairs that what superfunds have come to be , is so diminished that it has no ambition to run on schemes for more than 10 years. But what is more revealing is that while a superfund is constrained to produce returns between 1.5% and 2.5% above gilts, Kempen’s assumptions for schemes with an additional sponsor are for returns 3.5% to 4.5% higher. That is bold.
For returns as high as Kempen assumes for CSJPs there will need to be a substantial increase in the proportion of a DB’s scheme being return seeking and some heroic assumptions on the returns CSJPs can expect on those assets.
Small wonder that Kempen consider
The key takeaway here is that there is great potential to generate a large amount of surplus within the UK DB pensions market, even after allowing for a continuation in the significant buyout activity of £50 billion per year. This opportunity is overwhelmingly anchored by larger schemes (£500m+).
The opportunity cost of buy-out.
You would have thought, the opportunity being available to most sponsors to take back surplus to und better pensions and/or invest in the company for greater productivity, that there would be considerable demand for capital backed journey plans. There is.
However, no recent CBJPs have been reported since the emergence of schemes from the LDI trauma and one has to ask why. I have to agree with Kempen’s conclusion
The UK’s defined benefit market is huge and is if Kempen’s assumptions are correct, it has the capacity to transform large corporate finances,
The industry finds itself in unique situation which very few would have predicted at the height of the COVID pandemic in 2020. We estimate the surplus as at February 2024 (on a proxy buyout basis) to be in the region of £210bn. Even allowing for a blockbuster decade of buyout activity at £50bn p.a., aggregate surpluses could reach half a trillion pounds across the industry over the next 10 years.
The biggest risk pension schemes face today is “opportunity risk”. The opportunity is to get a share of that £500bn surplus, the risk is failing to do so.
In “comments” over the weekend, John Mather asked whether the imputed deficits that drove the leverage of LDI could be compared with the tactics of advisers frightening savers into pension scams. Pension Oldie’s response deserves more prominence than the comments section.
The answer is that both can be devastating. However as in all scams the individual is left with a feeling of guilt from a feeling of person responsibility.
In the case of LDI the responsibility is shifted to the Trustees and their advisors (also in my view The Pensions Regulator) in encouraging schemes to switch their investments to those with negative real returns. Also the bulk of the losses were and are being borne by the scheme sponsor in deficit contributions that should not have been required.
Also the individual pensioner has lost potential pension prospects (a loss of expectation which he or she may not have recognised) rather than an absolute financial loss. So in spite the vastly increased number of members and pensioners affected, the loss feels remote and hypothetic to the individual even though the effect may not be any less.
For example do the Debenham’s employees who lost their jobs blame it on the £350M reported deficit that has proved to be entirely illusory?
We have thrown away £166 bn in assets by not unwinding LDI in time, let’s not throw away another £500 bn by buying out our DB plans.