The Pensions Regulator has published an annual DB funding statement that is their snapshot of the state of funding of the 5000 or so remaining schemes in the PPF 7800.
Buy-out is going well, consolidation not so, but the general view is optimistic, many schemes that had given up on paying pensions are now actively considering what it would mean to “run on” and many sponsors are looking at pension schemes as an asset again. Reading Stephanie Hawthorne’s article on end-game solutions or reactions to the DB funding statement suggests that there is considerably more support for schemes paying pensions than was imagined even a year ago.
Rethinking strategies
In last year’s statement, the Pensions Regulator grouped schemes broadly into three categories.
- Funding level is at or above buy-out.
- Funding level is above technical provisions but below buy-out.
- Funding level is below technical provisions.
They are rolling on with this
For those in group one , TPR state
Schemes in this group currently have the main options of buying out or running on. Consolidation might be an option subject to gateway tests.
I take this as an acknowledgement that superfunds are able to swim in a wider pool, but that capacity for consolidation is rather less than anticipated. Run on or consolidation is now framed as a bridge to buy-out, a rather less ambitious vision than that of the 2018 consultation.
Given constraints in the insurance market, some schemes may adopt a strategy to run on in the short to medium term, and buy-out when specific targets are met, for example when surplus, maturity, cash out flow or asset size hits certain levels. We expect trustees to document their strategy and explain why it is in the best interest of members.
There is acknowledgement that buy-out may not be in the best interest of members.
If the strategy is to buy-out liabilities with an insurance company, the scheme rules may give trustees some guidance and they may need to take advice and consult the employer. Among other things, trustees will need to consider whether proceeding with an actual buy-out, either outright or in stages, is the best way to protect members’ benefits and achieve the best price.
A hat is tipped to Railpen and the Church of England’s sustainability charter and encouragingly, the interests of members . We are asked to consider
…. the effect of buy-out on the possibility of future discretionary increases in payment may also be a relevant consideration.
There continues to be an obsession with the employer covenant. Schemes that want to run-on are advised to establish a “risk-buffer” to ensure that they are effectively over-funded. This can only be at the expense of productive capital that could be used elsewhere, DC members and the productive capital needed by the sponsor to deliver future benefits come to mind.
And trustees are advised that whatever they do, they do not do so offer their own backs.
Whichever option trustees choose, they may need to take advice about the risks and benefits of doing so, and their relevant duties.
The idea that professional trustees may know as much if not more than the advisers is not as yet countenanced. Many of these schemes are now operating in an autonomous fashion with consultants being used to test and validate, rather than to devise strategy. I expect to see more on the rise of the autonomous trustee in years to come.
The schemes in group two
Although TPR don’t say this, there is an assumption that solvent schemes will aspire to buy-out. However, the emphasis here is changing
Schemes may consider the emerging options such as consolidators, capital-backed journey plans, and the recent consultation on a public sector consolidator via the Pension Protection Fund. We would expect improved funding levels to allow for such options to be explored and whether they would be in members’ interests.
But the Pensions Regulator shows a degree of caution that suggests that innovation is still “tomorrow’s world”
It may be reasonable for some trustees to take a ‘wait and see’ approach, given the immaturity of these options.
And schemes are asked to specifically “wait and see” what TPR has to say on new ideas
We intend to publish guidance on DB alternative arrangements for consolidation later this year, which will provide more detail.
Of course for many distressed schemes, there is not time to “wait and see“
In recent weeks, I have come across examples of trustees preferring the haircut of the PPF to the offer of co-sponsorship through a capital backed journey plan.
There are very real issues here to do with member’s pensions. A wait and see strategy is not appropriate where a scheme loses its sponsor and where the funding position is too weak to consider self-sufficiency. But there are alternative solutions in the market to help and I hope that the Pensions Regulator will recognise that the time to act on these is now.
The DB funding code
We had been published the final version of the long consulted upon DB funding code in April, it is now rumoured to be publishable in the summer with implementation from September.
If this document is its prequel, then those who anticipate a radical departure from the past will be disappointed. There are some comments on yesterday’s statement expressing disappointment that the Pensions Regulator is not moving faster towards a more permissive regime that allows schemes more autonomy on investment and less reliance on covenant.
My feeling is that this paper is at the vanguard of actual practice at TPR and that the actual guidance being given by case-workers continues to lag the positive notes achieved in this document.
The delays in the production of the DB funding code reflect the deep conservatism within a regulator that has always taken “risk-based” to mean “risk elimination”. That points to a quiet graveyard – not the destination of choice for me!
TPR maintain that more than 50% of schemes are buy-out or better funded – in September 2023 their figure was 56% – some 2800 schemes, up from around 400 schemes in December 2021. By contrast, using the ONS figures the number of schemes funded that well has risen from around 450 in 2021 to just 1400 schemes in September 2023 (28%) – half TPR’s estimate. The ONS increase is more than enough to account for the increased levels of interest and activity we see in buy-out.
Iain Clacher and I believe that the ONS figures are the more reliable and accurate, and would be very happy to offer our reasons for that belief.
As well as Con’s very well researched point above. TPR’s analysis misses a further important point that TPR’s encouragement to all pension schemes to fund in line with their unrealistically prudent valuation assumptions has significantly downgraded the income earning quality of the assets of pensions schemes. Furthermore this will only emerge with the passage of time.
The most frequently occurring valuation dates of the T19 tranche to which the 2024 Funding Statement refers are the 31st December 2023 and 31st March 2024. The real gilt yields (against the derived 20 year RPI inflation assumption) used for the previous valuations for this group were minus 2.58% (31/12/20) and minus 2.20% (31/3/21). This compares with the current valuation values of plus 0.84% (31/12/23) and plus 0.97% (31/12/24). The current values are much more in line with the long term values if you disregard quantitative easing distortions (the real yield at the 31st December 2003 a possible base date used for the establishment of the Technical Provisions model was plus 2%).
The implications of a negative gilt yield being used for the valuation models is that a scheme will only report a surplus if that surplus is large enough to cover the shortfall in annual investment income over the lifetime of the benefits. More significantly the deficit recovery contributions being demanded from the employer sponsor are being set on the premise that the employer will have to make good on an annual basis the shortfall of 2.58%/2.2% of the RPI inflated pensions in that year.
The problem is that if Schemes set their investment policies to match/hedge these valuation assumptions, although the current valuation is now based on more realistic assumptions and will report a lower liabilities compared to asset values, the scheme will not be able to achieve the future investment income assumed by the current model. Deficits will emerge on subsequent valuations as the scheme sells its capital assets at an increased rate. Deficit contributions based on the previous valuations assumptions are not only now locked in but will need to increase to cover the loss of income from the excess asset sales.
This could be very significant – one “well” hedged scheme I have looked at with already a long asset backed recovery plan will require a quadrupling of the annual deficit contributions.
TPR appear to be missing a review of asset quality in their risk assessments.
Thanks PensionsOldie for highlighting how badly TPR have missunderstood DB scheme funding risks over the period of QE. It is really unfortunate that the damage done may well be terminal for many DB scheme sponsors, despite the long overdue “excitement” over “run on”.
As I have received a couple of emails on this, here are the estimates of the numbers of schemes in each of TPR’s statement categories.
ONS have 57% funded at TPs or better (using TPR’s liability figure), TPR has that at 87% So, TPR has around 4400 funded at TPs or better, less the 2800 funded at buyout+ means they have around 1600 schemes between TP and buy-out. ONS figures would be 2900 funded at TPs or better less the 1400 buyout+ means there would be 1500 by ONS reckoning.
The big difference is schemes in deficit – TPR around 650 while ONS would be around 2150.
But PPF says that there were 595 schemes in s179 deficit at September 23 – that leaves the spread between s179 and TPs very sparsely populated. Put another way, PPF is reporting 595 schemes below their £941 billion liability number, while TPR have just 650 below £1077 billion.