The PPF press release implies that in a month £5bn was apparently good news, though no one seems to be very much the happier.
Defined benefit (DB) pension scheme surpluses saw a further increase during June, Pension Protection Fund (PPF) analysis shows.
First Actuarial analysis , based on best estimate funding, shows no such thing with assets and liabilities matching and with the aggregate of schemes surpluses remaining stable.
The lifeboat fund said the aggregate surplus pf the 5,050 schemes in the PPF 7800 Index rose by nearly £5bn last month to £473.6bn from £468.8bn in May.
The funding ratio remained level at 149.4% by 30 June, while assets were recorded at £1,432.5bn and total liabilities were £958.9bn.
The index also revealed 451 schemes were in deficit with the deficit of such schemes sitting at £3.5bn – down slightly compared to May’s £3.6bn figure.
It should be noted that the stability of the funding position created by the First Actuarial Best Estimates Index is in marked contrast to the variety of other funding charts
Charts are produced by Professional Pensions showing recent levels of success in the funding of our pensions. We ought to be patting ourselves on the back – but we are not.
PPF chief actuary Shalin Bhagwan tells us the story of the past thirty days
“The story of the past month has largely been one of stability with the estimated funding ratio staying level with its position at the end of May – at 149.4% – as a 1.1% increase in liabilities was matched by an equal increase in assets held by eligible DB schemes.
“The primary driver behind the increase to both the liabilities and the assets was the small decrease to yields on fixed-interest gilts, after the Bank of England (BoE) hinted that a cut in policy rates might be on the cards in August.”
“As a result of these minor movements, the aggregate surplus of eligible DB schemes is estimated to have increased over the month to £473.6bn at the end of June, up £4.8bn from the end of May, while the deficit of the schemes in deficit is estimated to have fallen by £100m to £3.5bn.”
Yet most of these surpluses and deficits play out not over 30 days but more than 30 years. It just doesn’t make sense to most of us
Surely we have had enough of these wild stories of funding. Isn’t it time we learned from the FAB index that pensions schemes do not grow rich or poor depending on the oscillations of the gilt rate.
Project fear
I sense that trustees and scheme sponsors continue to regard their defined benefit liabilities as toxic, rather than as pensions that reward their current and former staff for years of valued service.
Each month the PPF has announced a rise or fall of aggregate deficits (and now surpluses) , each has been accompanied by sententious commentary from investment advisers, urging caution and further de-risking. The numbers (£5bn here, £5bn there) are so large as to be meaningless and indeed are.
We are not notably happier for being £5bn happier this month anymore than we are sad when we see our DC pots fall by thousands in a day. We simply see market forces at play and – for most of us – the endgame is not tomorrow but the day we end our allotted time.
And most of us are aware that however large these notional numbers are , there are real numbers behind them, the realisable value of assets, the nominal value of pensions to be paid, the cover that we have to meet these payments. These are not determined by the gilt rate but by long term investment returns against inflation and we all know that the best way to outperform inflation is by investing in real assets, the equity in corporates and infrastructure both private and public.
And we sigh when we realise that £166bn (according to Keating and Clacher) of “wealth” was burned in a few short days in September and October 2022. This was partly due to economic mis-management by Government and partly by a failure of pension schemes and their advisers to understand the risks of their embedded LDI programs.
In answer to the question posed by the title of this blog, we are immune to the numbers published by the PPF , partly because the numbers are so large that we cannot relate to them in anything more than an abstract fashion, partly because the deficits and surpluses ebb and flow in what appears an arbitrary way and mostly because we have lost touch with what these surpluses and deficits mean in the first place.
If we have lost £166bn of real money to pay collateral calls to protect our hedges, then why are we talking of surpluses of half a trillion pounds? Have the liabilities to pension schemes changed so profoundly in the past five years? There are marginal changes in expectations of mortality and a different outlook for inflation but there is nothing about our future expectations for our retirement that can make sense of the carnage both DB and DC investors experienced from the gilt and bond markets in 2022.
We still need a £1.55 to buy four pints of milk in Tesco and if we have not got that money because we paid it to the bank to protect the price of milk rising, we go without milk. Many companies are having to fund their pensions today to pay their milk bills because they paid for needless protection in 2022.
And we no longer feel that paying pensions (the equivalent of tomorrow’s milk round) is something that companies ought to be doing. Though it is something that Government does for all public service employees.
Put at its most simple, we have stopped caring about our future pension bills because we have lost our common purpose – which was to make sure pensions got paid- milk got bought and drunk.
To a very large degree , it is because we have been blinded by the fear of volatility of pension liabilities where no such volatility exists. FABI is a consistent straight line which tells trustees that so long as they hold their nerve, invest in real assets, they can pay their pensions. The wild fluctuations between deficits and surpluses that characterise mark to market approaches (all the other lines), serve only to disillusion the C-Suite, project fear has turned us against the payments we used to cherish, turned pensions into liabilities and created an incredibility in the numbers produced for us each month by the PPF.
There are ongoing discrepancies in TPR and PPF estimates of scheme assets relative to those surveyed by ONS – at Q3 2023 £249 billion fewer (ONS – TPR) and growing.
I understand that an attempt at reconciliation of the differences is under way and look forward to its publication.
The fundamental issue is that the liability side of the surplus/deficit calculation of most of the statutory and regulatory measures uses the return of the most volatile asset class to discount the relatively stable and predictable future cash outflows. The First Actuarial index highlights that the dividend cash flow from equity investments has been remarkably stable and highly correlated with inflation over the period charted. For all assets classes if market values go up the yield goes down.
Disregarding asset based valuations for statutory and regulatory purposes is rooted in s75 of the Pensions Act 1995 which defines the deficit to be regarded as a debt on the employer to be calculated by an actuary at the time of employer withdrawing from the scheme either voluntarily or because of insolvency. The Occupational Pension Schemes (Employer Debt) Regulations 2005 provide for the section 75 debt to be calculated by estimating the cost of buying out the scheme benefits by purchasing matching annuity policies from an insurance company. The Actuary is therefore estimating the buy-out cost. Further this is not adjusted to match the actual cost (BESTrustees plc v Kaupthing Singer & Friedlander Limited). The actuarial profession, probably not unreasonably at the time, determined that the buy-out cost should be estimated using the gilt yield measure.
This then effectively created a cartel among the insurance companies as they were aware of the price the ceding pension scheme was expecting to pay for the transfer of the future liabilities. When quantitative easing was introduced and gilt yields were artificially pushed down, the insurance companies effectively increased their prices even though they do not generally use gilts to service their liabilities. Creating effectively a profit windfall for the insurers that was not mitigated by market competition.
Where are we now?:
We have a large proportion of pension schemes which sucked unnecessary deficit recover contributions out of the employers to meet the artificially inflated buy-out cost or technical provisions deficits measured at the valuation date. To match that cost many schemes sold stable cash flow income earning assets in favour of low income earning assets without regard to the potential capital or sales value of those assets. The real cost of the LDI crisis is therefore not just £166BN lost to the hedging counterparties in the few days in September/October 2022 but also a substantial proportion of the £600BN decrease in the asset value of the pension schemes between June 2022 and December 2023 reported by the ONS and supported by Clacher and Keating. To this we need to add the effect of the reduced future income cash flows to the scheme from the buy-in policies and other low income assets bought from the capital assets of the scheme only after that capital value had been reduced by holding “matching” assets.
The insurance companies are now faced with a situation where their profit and risk margins have been eroded but because of the market distortions created by the artificiality of the gilt yield pricing model they know their competitors are likely to undercut them if they seek to maintain risk/profit margins. The insurance companies have therefore had to extend their own investment range into other geographic markets or to sub-underwrite to match the liabilities they are insuring. This exposes them to different risks from those represented in the gilt yield pricing model.
I therefore believe the true cost to the pension prospects of beneficiaries and the UK economy arising out of the use of inappropriate valuation measure and exposed by the LDI crisis is measured in the £Trillions!
It is the valuation measurements that have destroyed the value for money of the employee and employer contributions paid into a DB pension scheme in the UK.