I have had a PDF in my inbox for some time and I finally got to read it this morning. It’s from William McGrath, who many will know is a former CEO of Aga and someone who thinks a lot about funding DB pension plans.
I think this is well said by William. William and I had a long conversation yesterday about how we can get action amongst pension trustees and concluded that we needed employers to wake up to the brilliance of their pensions and stop considering them as things to de-risk.
We have cleverer people than I who express their feelings using phrases such as William’s. I may have been cleverer before my accident (I can’t remember) but I think back to Bob Dylan who refused to accept a prestigious literary award in Stockholm claiming that he was working his hardest to be a musician.
I don’t aspire to be clever or a good blogger. WTW have invited for another year of being humiliated by not winning any awards in their show. That really isn’t the point. William and I sat down and worked out the things we could do to help Run on 4 Good. I went away to think some more and I still haven’t got the idea properly sorted in my head. This is not about showing off, it’s about getting things done.
But I think there are enough people who want pensions to Run on 4 Good that we could get a Concrete Proposal to Government and could do so by March 11th when the Pensions Minister is coming to Edinburgh to discuss with us what Government can do by way of simple additives to be the trigger for growth.
I hope that William and his gang can join up with John and his gang and the Pension Plowman and his gang because we really have got a Pension Minister who has the capacity to understand and the determination to do concrete things.
As I have pointed out before re-opening to DB accrual at an affordable accrual rate is the obvious solution for any company retaining responsibility for a DB pension promise whether in surplus or in deficit, whether existing assets have been used to purchase a bulk annuity product or not.
The assumption of additional risk the company is taking on is entirely a one sided analysis based on a single base point measurement of a highly volatile market determined factor of little fundamental relevance which effectively diminishes the impact of all other factors. The key determinant of success will be whether the pension scheme will achieve an investment return which outstrips the inflationary increases to benefits for the foreseeable future. The reported investment returns of one mid size open DB scheme – cash flow positive because the contributions paid in (both employer and employee) have inflated faster than the pensions paid out.
“The investment returns achieved by the Scheme compared to CPIH Inflation have been as follows:
Investment Return Inflation (CPIH)
1 year to 31st March 2024 13.8% 3.2%
5 years to 31st March 2024 6.3% p.a. 4.2% p.a.
10 years to 31st March 2024 7.2% p.a. 2.9% p.a.
15 years to 31st March 2024 7.5% p.a. 2.8% p.a.”
I do not believe these figures are untypical of pension schemes who have not sought to hedge liabilities against gilt yields.
Lets stop this nonsense about trying to link the assumptions about the future to the past. This could most easily be achieved by setting a single percentage value for the assumption about the future and have a discussion about how appropriate that figure is, e.g, using the figures above.
Should we assume future inflation should be 2.8% or 4.2% or just say 3.5%
Should we then discount the future liabilities by 4.9% p.a. (31/3/14 Gilts + 0.5%) or 1.4% p.a. (31/3/21 Gilts + 0.5%) or just say 4.5% to determine the capital value of the assets the Scheme needs to meet the pension promises on a low dependence basis.
Having done that the Trustees and Employer can the plan how to build the assets up (using both employee and employer contributions plus investment returns) to build a sufficient surplus of assets to meet risk margins. Once that risk margin has been reached the employer could then scale down its “balance of cost” contributions and thereby reduce its future employment costs.
To me this is more likely to result in sustained economic growth than a one off surplus distribution, probably being distributed to current shareholders by way of dividend or share buy backs (in many cases to shareholders outside the UK), plus a fixed commitment to pay elevated DC contributions likely to provide a much poorer pension income outcome for employees.
Sorry the format of the investment return versus inflation table was lost when I posted
Thank you, everything on this blog and comments makes great sense.
But corporates (and Trustees) will find it difficult if not impossible to embrace (or even accept) growth without a clear and distinct change in the TPR regulatory regime. A system that actively herds schemes to derisk/disinvest, strong armed up by laws under the 2021 Act that criminalises risk, is not in any way conducive to growth and investment. The lawyers and actuaries will remain stuck, obliged to advise on the Regulatory risk (not the investment risk) from action, when inaction is the prescribed default?
I’ll put it on the blog tomorrow! Thanks Oldie
PensionsOldie, thank you for setting out the Scheme returns v CPIH achieved over the 15 years to 31/3/24. Depending on the longer time period chosen the Scheme real return ranges from 2.1% to 4.7%, driven in part by the one real year return to 31/3/24 of 10.6%.
Had that last year been 0% the 15 year return would have been 6.8% and 4% over CPIH, which is remarkable. Had the last year return lost half the asset value, the return over 15 years would still be a respectable 4.6% pa, i.e. 1.8% pa over CPIH.
When one considers a 1% improvement in long term yield equates roughly to a 20% reduction in pension costs, it highlights the lunacy of avoiding investing in real assets and piling into risk reduction techniques to “stabilise” “notional” funding rates.
We need more Pension fund trustees to highlight their experiences when dealing with TPR and their adviser recommendations to “derisk” and the resulting negative or positive impact on the sponsor.
Jnamdoc is also correct in highlighting the impact of the 2021 pensions Act, and the knock on emphasis on perceived safety. A parable comes to mind of the son who thought he was doing well to hold on to his coin rather than invest for the future.