The numbers predicted by Standard Life for insurers taking on DB assets and liabilities are well down on estimates at the beginning of this year. Trustees are seeing risk as growth and questioning further de-risking.
There will come a time when “risk” will not be a dirty work in pensions. At today’s conversation between Jo Cumbo and Tom McPhail we had an interesting comment from Chris Giles about what he wanted to see from pensions
We have spent a quarter of a century de-risking pensions using gilts + rates to measure, now we want to measure the growth of pensions using inflation.
When working at First Actuarial I marketed the First Actuarial Best Estimate Index (it became known as FABI) . This FAB Index showed the financial position of the UK’s 5,131 DB pension funds on a long-term basis, allowing for realistic future investment returns.
It was updated every month using data from the PPF 7800 Index, to help trustees better understand the likely value of fund liabilities. It gave a different view of the state of pensions, one that saw them running on not selling off assets and liabilities via buy out/in.
After 2023, when I had left, FABI was discontinued but it had served its purpose. It had showed trustees that there was a way to use risk to grow assets. It showed that there was a significant surplus in private defined benefit funded pension and that even though assets had been decimated by the problems of 2022, funding remained positive. Of course the cost of buy-out is that it values with a risk-free rate.
If there was a conclusion I could draw , it was that funding using a risk free measure abolished the upside of long-term investment.
Finding risk is growth
Nowadays, we have CDC, where liabilities are in line with assets ; where there can be no surplus or deficit and where investment is everything. Of course the wage that is paid to people in retirement is not guaranteed but it has more in common with the turquoise funding line of FABI than the estimates of funding based on the risk free return of gilts.
Risk over time brings value to schemes that can be passed on to members. It does not require deficit funding from sponsors nor the current agonising over surplus distribution. It looks at the DB pension scheme as something to value and be proud of. Sadly to Peter Cameron Brown and many like him, DB is not open to many schemes and if corporately funded pension schemes are to reopen they will do so as CDC.
I think most people would prefer a guaranteed pension to one driven by markets but the cost to people in terms of wages today of funding such arrangements on a gilt-based valuation basis makes that impossible. Chris Giles is right to say that only a funding target of a return above inflation , can work today.
That means embracing risk to achieve growth. That is something that pension schemes have forgotten, taught as they are by insurers who demand lock-down through de-risking.
The numbers de-risking are falling, the interest in CDC is growing
The expected amount of DB assets and liabilities transferred to insurance companies is down on what was estimated and Claire Altmann considers what risk transfers in the second half of this year will come from large DB schemes.
“The government’s planned review of flexible apportionment arrangements highlights that regulatory safeguards are still evolving as new DB models emerge, potentially strengthening the appeal of established routes such as buy-in and buyout.
“Against this backdrop, while run-on and alternatives are a bigger part of the discussion, ongoing uncertainty and market risk mean many trustees are still likely to favour buy-ins and buyout to lock in gains and deliver certainty for members.”
Standard Life are looking for the hangover of preparation by a few large schemes while the majority of schemes pull back from the precipice of buy-out.
Meanwhile, employers are seeing the unfairness of having one group of employees getting guarantees while the rest get Defined Contribution Schemes that have no pension and require employees to take all the risk on their own. The collective approach is infact a way of sharing the risk collectively and the measure of the pension payable is based on a long term assumption of growth based on what investments have done, typically inflation +4/5% with an assumption of inflation at 3/4%. This risk be taken on and it will mean CDC funds will not be locked into gilts but will buy investments in growth.
The hangover of de-risking will go on forever in DB as many pension schemes pack up their schemes and hand them to insurers, but an increasing of DB schemes will stay open for longer . Meanwhile the old style of DB that relied on growth as well as contributions will return as Whole of Life CDC takes over large parts of DC workplace pensions.
The insurers may wake up to this, they are welcome to join the proprietors of CDC and move from de-risking to re-risking. But they will be paying catch up. Risk is growth over the long term and while DB schemes are largely finite in their end-games, CDC have infinite time horizons. Here is another First Actuarial chart to explain why.
