The artful Dutch dashboard team
Britain prepares for Richard’s grand tour of the Nordics in search of dashboard inspiration. It sounds like he’s found it and let’s hope he’ll be sharing more of the insights he’s had over the past few days with us – over the next few weeks!
“More still needs to be done to address significant weaknesses in the ability of defined benefit pension schemes to manage risk, MPs say today, in a report that warns that their investments must never again be allowed to jeopardise the stability of the UK economy as they did during the events of September last year.”
That’s the message of the the Work and Pensions Committee’s Report on DB pension schemes with liability driven investments (LDI) The report outlines a ‘missed opportunity’ to improve resilience. After the Bank of England spotted the potential risks of LDI use in 2018, the Pensions Regulator conducted a survey but neglected to look at small pension funds, which were the cause of September’s instability because of the nature of their arrangements.
The report concluded that there was also no system put in place to collect data on how LDI was used. It was not known that leverage grew, giving rise to systemic risk.
The Committee concluded that the weaknesses meant that LDI funds lacked the resilience to cope with the sharp rises in gilt yields, initially triggered by the ‘mini-Budget’ last year, leading to the Bank of England being forced to intervene to protect financial stability.
Setting out some key areas of change for the Government and TPR, the Committee questions why TPR encouraged schemes to use complex financial products involving LDI and relied on trustees to act as the first line of defence, despite its long-standing concerns that some of them were not up to the job, and its awareness that it did not have sight of what individual schemes were doing.
The Committee called for more systemic collection of data and for regulators to work together to analyse it to spot emerging risks.
It called on DWP to consider whether the use of LDIs should be restricted while the process of improving standards of scheme governance takes place.
Stephen Timms MP, Chair of the Work and Pensions Committee, said:
“The turbulence around last year’s ‘mini-Budget’ exposed a lax approach to regulation.
Despite the dangers of the use of LDI being identified five years ago, there was a lack of focus from TPR and inadequate data. The use of leverage by DB pension funds grew, giving rise to systemic risk in a way that was not visible to regulators until crisis hit in September last year.
“Although the speed and scale of the rise in gilt yields was unprecedented, the consequences for DB pension funds should have been foreseen and TPR should not have been blindsided.
Gaps in regulation and the system for managing systemic risks must now be addressed to ensure that DB pension scheme investments never again threaten the stability of the UK economy.”
TPR to specify minimum levels of resilience to LDI risks
• DWP and TPR should explain how they intend to deliver on the Bank of England’s Financial Policy Committee recommendations that TPR should specify the minimum levels of resilience for LDI arrangements in which pension schemes invest and work with other regulators, to ensure that LDI funds maintain the resilience that has been built up
TPR to get LDI updates from trustees
• TPR should consider requiring trustees to report regularly on their use of LDI and develop a strategy for engaging more closely with schemes based on the results
DWP to publish response to 2018 consolidation response
• DWP should publish its response to the consultation on DB consolidation by the end of
October and work with TPR to improve the regulation of trustees and standards of
governance. (the DWP has attempted to publish this response three times and been prevented from doing so by another department).
L plates for trustees till they past LDI risks test.
• Given the time it will take to consult on, legislate for, and implement measures to improve governance, DWP should consider whether the use of LDI could be restricted, for example, based on a test related to a trustee board’s ability to understand and manage the risks involved
Investment consultants should be directly regulated by FCA
• The Government should bring forward plans for investment consultants to be brought within the FCA’s regulatory perimeter
DB funding code should be put on hold
• In light of the FPC’s recommendation for TPR to take account of financial stability, DWP and TPR should halt their existing plans for a new funding regime, at least until they have
produced a full impact assessment for the proposals, including the impact on financial
stability and on open DB schemes.
We’ve published new results from the Financial Survey of Pension Schemes (FSPS).
Covering Oct to Dec 2022, this includes membership, income and expenditure, transactions, assets, and liabilities of pension schemes.
➡️ https://t.co/apyUkWp97j pic.twitter.com/nDllINbzQy
— Office for National Statistics (ONS) (@ONS) June 22, 2023
That’s the headline that accompanies the news that in 2022, Corporate DB plans lost very nearly £600bn of their asset base, falling in aggregate value from £1.8bn to £1.2bn. The slightly less bad news was that in Q4 2022 schemes only shed 3% of their assets.
In their session in parliament , Webb debated with Keating and Clacher over what were referred to as “technical” differences in valuations. The ONS figures suggest that not only have schemes lost considerably more in 2022 than previously thought, but they cast doubt on the “remarkably robust” state of our corporate DB pension plans
The ONS numbers show scheme assets having declined to £1,230 billion from a revised £1,269 in September. This is a loss of £39bn on the quarter but £591 billion from the beginning of 2022. In these tables T2021 represents Keating and Clacher’s estimates sent to the Work and Pensions Committee prior to its meeting on 21st June
T2021 is Keating/Clacher pre ONS guess at asset fall in 2022
TPR and PPF have respectively estimates of residual assets at the end of 2022 which are £146 billion and £179 billion higher than those of Keating/Clacher and the ONS. These are the differences between projections and reality.
The latest ONS figures are within Keating and Clacher’s range of expected values, they should be congratulated . Using the ONS asset values (rather than the rosier projections of TPR and PPF), they see the following funding ratios being reported.
These do not show the resilience previously reported, they show a slight improvement in 2022 – but not the “best possible world” scenario claimed by one commentator.
Put in graphical form the difference between the optimistic forecasts of the PPF and TPR (green and blue) forecasts of asset declines can be compared with the sharply lower ONS numbers (in red). The purple line is Keating and Clacher’s estimates of what has happened to assets in Q1 2023.
It is hard to understand why so many senior people in the DB pension world are so keen to promote funding as “remarkably robust”. Derek Benstead in his evidence was keen to point out that in the real world , pensions are paid from assets and the pension liabilities are actually going up because of inflation. While the “model” that discounts liabilities has drastically reduced the theoretical liabilities, they haven’t reduced the amount pension schemes have to pay.
Con Keating made the point that that a higher discount rate implies a higher return on assets, there is no evidence that assets are any more likely to increase in value than before discount rates shot up. Benstead points out that the actual amount of interest a gilt pays remains constant, no matter what the yield says.
In short – financial common sense tells us that liabilities are in £sd the same as before inflation came along , assets are £600bn lower – a truly frightening number and pension schemes have blown their once in a generation opportunity to make a difference to pensions , blowing a good deal of that £600bn on LDI as the rest of this blog will show.
The ONS suggest that the falls in corporate DB gilt and corporate bond holding over the final quarter of the year was to meet ongoing liquidity calls from LDI
The loss of nearly £600bn in assets means that the capital reservoir within UK pensions is depleted. Where has the money gone? It has gone to banks who are on the other side of LDI trades and it has purchased little in return. Schemes that did not pay to keep hedges in 2022 are now super-strong and at the front of the queue to buy-out. Schemes with depleted assets may have the technical solvency to buy-out but their lack of assets make them less attractive to insurers, something L&G’s Nigel Wilson told the House of Lords regulatory committee when pressed on buy-out annuity pricing.
The really resilient schemes are generally not in the private sector, they are public sector schemes or quasi public sector schemes (as John Ralfe called them) such as USS and Rail Pen.
The hope that UK pensions will be a source of productive capital for the UK economy now rests with these open DB pension schemes
The vast majority of allocation to illiquids is in the public sector defined benefit sector. Though there has been an uptick in private sector DB allocation (probably due to illiquids not being offloaded to meet collateral calls), the DC schemes that have been urged to invest in long term assets have simply not done so.
The ONS paint a picture of an asset base for what we once called Britain’s great economic miracle in sharp decline in 2022 – with little sign of recovery so far in 2023.
It remains to be seen just what will happen with DC assets, but the signs so far are that consolidators are not competing on value but price.
I see little evidence to justify Steve Webb’s claim . The only thing buoying up UK pensions are the high interest rates that look like persisting through 2023 and the hedges still in place. It is hard to sell to the UK population that the security of pensions is now about interest rate hedges, but that is the grim reality. For those with hedges intact, the game’s about keeping a brave face, for those who have no hedges, they can only hope interest rates remain high. That doesn’t look like resilience to me.
The various responses from the trade and national press demonstrate what a mess we have got ourselves into trying to protect people from combining their pension pots.
Guy Opperman made it clear this time last year that the DWP’s intention in legislating for protections was not being carried out and that the abundance of red and amber bunting being chucked at savers was causing as much trouble as it solved.
As the headlines proclaim, the statistics pumped out in the DWP’s report on the matter are being variously interpreted as
The attempt to regulate non-advised DC to DC transfers has resulted in farcical situations where people have turned up for interviews with MaPS with no idea of what they are there for and for MaPS to be equally clueless. Most red flags seem to have been thrown because customers have expressed disbelief that they can’t more their money from one authorised pension scheme to another – a double yellow for dangerous play and subsequent dissent.
This appears to be the DWP position on the matter
In the 290,000 transfers the DWP looked at, 2,400 transfers were given an amber flag. The most common reason was the inclusion of overseas investments in the receiving scheme.
In total 300 red flags were raised. In almost half the cases (47%) this was because the customer had failed to provide the right information. And in a further quarter (26%) because the customer hadn’t provided evidence that they had attended a MoneyHelper appointment.
The DWP said it will continue to work with the industry to resolve areas where transfer requests are being delayed or blocked, especially where an amber flag is raised because the scheme includes overseas investment. And where a red flag is raised because the scheme offers an incentive.
Over the last 18 months, the waiting time for a MoneyHelper safeguarding appointment has gone up from 2 weeks to 6 weeks.
My suspicion is that there is no resource to bring fraudsters to justice, that many of the incidents reported as fraud were well-intentioned but breaches of the complex regulations and that we are now in that most awkward of messes that the right thing to do “combine pension pots” is turning into the wrong thing to do “helping people to combine pension pots”.
With insufficient advice and guidance to go round, most people with small pots are doing the best they can by following the financial promotions made by the likes of Standard Life and Pension Bee. So long as taking money from institutional to retail products is considered a poor choice , we will continue to see trustees and their administrators finding reasons to throw flags
In its conclusion, the DWP said the initial policy intent of the regulations remains appropriate and that
“it is estimated that the regulations have stopped approximately 2000 transfers taking place which may have been scams/fraudulent”.
In all this investigation , something is missing. Is there any evidence among the 290,000 transfer requests looked at that anyone is actually being scammed?
Having read the DWP’s paper – link here I now have closer inspection of how this 2000 figure was arrived at. Footnote 15 , suggests that it is an extrapolation of a much smaller number of potential frauds – identified as “red flags”. So who is behind the potential fraud?
Are red flags being referred to action fraud? Are they being investigated by the FCA? Is anything being done about suspect transfers? I suspect not/
If nothing is being done about the people behind these supposedly fraudulent transactions, then we might conclude that these supposed fraudsters continue as a menace to pensioners. An alternative conclusion is that there is insufficient evidence to merit any further action, let alone naming and shaming
Transparency is the best disinfectant and if the regulators have the evidence, why don’t they warn us public who we should be avoiding?
I suspect that the vast majority of amber and red flags are a huge embarrassment and that resource would be better employed ensuring that all authorised pensions are value for money and that anyone looking to transfer authorised pensions to an un-authorised scheme , is immediately investigated , prosecuted and warned off.
At one point in yesterday’s parliamentary session on DB funding, a sharp MP likened the DP optimists to Ben Stokes “Baz ball” cricketers – gung-ho with news of current surpluses. This put Keating and Clacher in Australia’s “winning” position -as they took a more cautious approach to supposed surpluses.
It’s an odd comparison as the PLSA and LCP positions were based on numbers from the PPF and TPR – hardly the most dynamic of teams, maybe a case of the establishment getting carried on a wave of “irrational exuberance”.
To make sense of what went on in the first session of the Work and Pensions Committee’s inquiry into the current state of UK DB pensions we need definitive data and that may arrive today in the form of ONS numbers on the actual state of pensions to the end of 2022, taking into account much that has been missed in the PPF and TPR projections. I say “may” as there is increasing doubt about the reliability of private market valuations which appear to be defying gravity at the moment.
Steve Webb was at the meeting to promote a new way to fund DB schemes to issue further accrual and pay their own pensions (aka stay open). Keating and Clacher were at the meeting to point out that the current optimism was based on discount rates having risen from one or two percent to values in the four five and six percent range. Keating asked the Committee if it thought that the assets of schemes in many cases will not deliver returns to match, an assumption that could not be justified by the remaining asset base of DB pensions.
In practice, the two sides came together at the end of the meeting to agree that both sides wanted the same thing with “pensions being the winner”. In the high octane world generated by genuinely engaged MPs and some highly articulate speakers, it was left to the PLSA, Joe Dabrowski to play the umpire – while he did not speak for the regulator – he sounded like one!
We didn’t learn much new at the session other than LCP has evolved its thinking to include what it calls “super – levies” , an additional voluntary payment that can be paid to the PPF to ensure 100% protection in the event of sponsor failure. The super levy is an insurance premium akin to the ideas promoted by Brighton Rock, Con Keating’s proposed covenant insurer. Small wonder then that harmony broke out in the conclusion if not the early parts of the session.
There seemed to be universal support on the panel for LCP’s proposals, albeit at a high level. The PLSA called for a Government consultation.
The second half of the morning’s oral evidence was given over to a discussion on what DB schemes can do to improve the pensions being paid to UK workers in the light of the greater optimism for DB pensions (whether grounded in fact or not).
If you have the chance to listen to this second session, I suggest you do. It’s characterized by a sharp dynamic between the Panglossian view that DB pensions are in the best place in the best possible world (John Ralfe’s view) and the view of other panelists that the current regulatory structure is unsuitable for a world that has moved on .
This latter view was eloquently expressed by First Actuarial’s Derek Benstead, Railpen’s Martin Hunter and the IFOA’s Leah Evans.
This session is characterized by the articulacy of all four participants , advocating two very different viewpoints.
Many people have given up on DB – certainly corporately funded DB – consigning it to the pensions legacy which will be dealt with by insurance companies converting pension promises into annuities.
The two hours of debate, which were hugely entertaining, very well argued and admirably supported by MPs who were well briefed, suggests that for 10.9m people in the UK who will get workplace DB pensions , the debate is anything but over.
The large open schemes – USS and Railpen, collectively make up a third by membership of future accrual in the corporate sector but the other two thirds still accruing cannot be ignored. While it is unlikely that we will see many schemes reopening for future accrual under the current regulations, there is a different paradigm , foreseen in this debate with a Pension Regulator operating to different objectives, with the PPF serving a different function and with the regulations around funding switching from discouraging to encouraging the accrual and payment of pensions.
None of these thing are here yet, they may never arrive, but they are now being openly discussed. Add to this , the avowed intent of both DWP and TPR to consider new ideas around risk sharing and the eventual arrival of CDC and we may consider the future a future with pensions and not just pots.
As for pensions Bazball, we can liken what we heard today to what is happening to test cricket. Test cricket has been brought back to life by the actions of a few forward looking and confident people , pensions may be following in the same direction. Thankfully, there is a healthy skepticism to counter the ebullience, both in cricket and in pensions!
On a day when we are likely to see our mortgages hiked again , it’s hard for many people saving into pensions to see ours as the best possible world.
For those who have been enjoying Richard Smith’s European Odyssey, here is his latest report -from Oslo
Here’s what the Norwegian dashboard looks like and here are the people that Richard met.
What is coming out of these visits is consistent. “Bold , Clear and Expansive” aren’t words that I’d employ about UK pension dashboards – to date. But that could change.
The Pension Dashboard Program is still looking for a CEO – have we found one in Richard?
This blog is part 2 of my thoughts on Barnett Waddingham’s excellent review of investment performance in fiduciary management in 2022. Though this paper does not talk of DC schemes, it has made me think again of the roles of DC Trustees and of the executives of the commercial workplace pensions, as well as the few “not for profit” DC occupational schemes remaining,
Although defined contribution plans no longer require us to buy pensions on a “money purchase” basis, they are still thought of as pension schemes. For the sponsoring employer and trustees , they are pension schemes without the liabilities. Without liabilities, DC schemes are no threat to a corporate’s balance sheet but they still require a sponsoring employer to employ trustees and employ much of the paraphanalia of a DB scheme.
For most employers , the need for trustees is non-existent, they would happily hand over decision making on workplace pensions to commercial entities such as GPPs and master trusts where they can participate but exert little control over the management of their staff’s money.
These relatively new commercial pensions are heavily reliant on fiduciary management which offers the combination of both investment advice and outsourcing of the day-to-day management of our pension money. The asset owners – the trustees – are now dominated by the scheme’s executive and their agents. Effectively most decision making taken by commercial workplace pensions is outsourced to “fiduciary management”.
The fiduciary management of DC schemes is carried out by actuaries, guided by lawyers and investment advisers who all too often look to replicate the strategies of defined benefit pensions for which they are trained. Effectively, the management and measurement of DC pensions replicate DB pensions
Performance is measured not for the saver for the scheme and value for money is to be assessed on scheme assets rather than the member’s experience.
When projections are required for statutory money purchase illustrations, they are produced using assumptions transferred across from DB schemes including the assumption that people will still purchase a pension using an annuity,
Finally, and most notoriously, DB has given us the DC lifecycle (AKA lifestyle) where the end of life is the point when people stop saving. This gives rise to an investment strategy designed to reduce the risks of purchasing a pension, which is not what most people do anymore.
Nevertheless , the concept of people in their fifties and sixties , needing to be invested in “low-risk” assets such as long-dated gilts (down 33%) and index-linked gilts (down 36% in a year), has led to poor outcomes amongst savers who have found themselves in default funds designed to protect them from financial vicissitude.
The chart above shows that 2022 was bad news for DB schemes. But because DC schemes replicate DB strategies, 2022 was equally bad for DC savers, young and old. They may not have had the shock of unwinding geared LDI positions, but they had little or no upside from the collapse in prices of fixed interest securities and had little exposure to growth assets other than in listed equities.
The issues that DC savers had in 2022 came from all elements of the there was no self haven.default fund’s portfolio – return seeking, cashflow matching, and liability hedging strategies.
But the issues were particularly severe for people at or close to the end of the savings phase of their pension journey. They are now stuck in assets that do not seek to create a return but simply await the taking of cash to line bank accounts , purchase annuities or switch to SIPPs from which money can be drawn down.
Unlike with DB schemes, fiduciaries of DC schemes have no liabilities to manage, but that does not stop the asset management being structured as if there were.
As this chart , presented by Newton at a recent playpen lunch shows, the fiduciary management of our money in default strategies at retirement is focussed on the DB return seeking, cashflow matching, and liability hedging strategies
“Cashflow matching” is represented by the red bars, where defaults transfer savers money from growth seeking assets to cash in expectation of 25% of the pot being cashed out at retirement. The dark blue bar replicates “liability hedging”, the idea that DC funds need to hedge against interest rates as savers are likely to be buying annuities. The decreasing exposure to return seeking assets (equities) is represented by the black bars. As mentioned above, these fiduciary strategies are based on the underlying concept that DC is a DB pension without the liabilities.
Much of this DB thinking has been transferred across to DC schemes without any challenge. The DC saver is treated as if he or she was in a DB scheme for no good reason other than that is what has always been the case.
Herein lies a fundamental problem with trusteeship (a literal translation of the Latin fiduciary). No one has properly defined what DC trusteeship should be about.
Many have tried. In 2013 the Pensions Regulator tried to encompass all responsibilities a trustee has to manage a good scheme in a document entitled “the 31 characteristics of a good DC scheme”. This has now been archived. The concept of DC trusteeship itself is looking an anachronism, a hangover from the days when trustees took decisions on DB schemes and did not outsource these decisions to fiduciary management. Trustees are subject to regulatory guidance which make them TPR’s compliance officers but they are increasingly sidelined when it comes to the management of our money.
Nowadays, the responsibility for how a default is constructed and the assets within the default falls to the funder of a few commercial mastertrusts and the executives of a handful of large DC schemes still taking active investment decisions. For a great number of workplace pensions that use contract based workplace pensions , there are no trustees and the fiduciary management rests with an insurer.
As more and more schemes consolidate, fiduciary management will rest with a small group of CIOs , an even smaller group of specialist investment consultants and with regulators likely to be increasingly interventionalist over issues such as TCFD, VFM and the exposure of assets to acceptable growth strategies.
Trustees are likely to become increasingly irrelevant as commercial master trusts and GPPs look to seek approval of the gatekeepers to new business (the consultants) and the regulators. This is a necessary consequence of moving to a commercial system of pension management – a system that is totally prevalent in DC.
Fiduciary management is the commercial equivalent of a trustee’s investment committee and it has all but taken over the running of DC schemes. The few DC trustees who remain are typically paid and often not even named, being “corporate trustees” representing their firms.
While we might like to think of trusteeship as a “not-for-profit” activity, in reality, it is now a professional vocation for those who get selected. Professional Trustees are much closer to being compliance officers than investment decision makers. They ensure compliance just as IGCs and GAAs ensure compliance to the instructions of regulators.
The real decision making on investment strategies and their implementation is taken by the funders of the large DC arrangements and most of them are vertically integrated, meaning that they are both executive to the pension scheme and part of the investment organisation that owns the platform or the fund management (or both) of the scheme.
This relatively new dynamic is not universal. There are still strong trustee chairs who will ensure that trustee boards exert their fiduciary control, but such trustees are rare. They should be encouraged as should be truly independent IGC and GAA chairs.
The health of our DC system requires that there is a proper distance between the trustee and the executive and that fiduciary management is subject to the oversight and over rule of powerful and expert trustee boards.
Put another way, without strong trustees who understand DC, we risk a pervasive system of fiduciary management where the needs of the member come second to the scheme.
Yesterday , the press decided to introduce a new number to the national consciousness. The number 6. It it the interest rate that mortgage payers will have to pay for a two year fix on their mortgage and it is up to three times the amount that some people have been paying to recently.
It is a bad news number and it will have many people reaching for their calculators to work out how much more they will be paying on their mortgage when the Bank of England increases interest rates again and again over the coming months. 6 is a tragic number.
If you go down to the woods today and consult with a good annuity broker (Retirement Line) , you may also hear the number. 6% is the rate a 60 year old can get for a joint life annuity
Annuity rates have risen, but not as fast as mortgage rates and that’s because of a lot of the annuity rate is based on what is going on with interest rates a lot further than 2 years out.
But the quoted 6% rate is still over 50% higher than the rate you could have got in December 2021. So if you are nursing a 30% loss on your pot last year, all is not lost.
This is all about the future cost of a pension, the same equation that means that your defined benefit pension scheme is now better funded than ever- despite it losing assets in 2022.
If you are about to take a big decision about a pension , you should be aware that though you probably have a lot less in your pot, what you have will buy you a lot more. Put another way – is your pot down more than 50%?
The rule of 4 says that a prudent drawdown rate is 4% of the amount in the pot. You can see from today’s tables that a 60 year old can get a guaranteed pension increasing at 3% pa on a joint life basis paying 4% of the pot swapped for a wage for life.
If you thought that 4% on your drawdown was an ok deal, you might like to think about swapping for a similar rate on a partially inflation protected annuity where your money is guaranteed not to run out. In my opinion – the rule of 4 applies to guaranteed annuities right now and will continue to do so, so long as interest rates remain high (at least for the next two years).
For a long time drawdown seemed a no-brainer. You didn’t need much va-va-voom in your investment portfolio to get the return needed to meet a drawdown of 4% and many people have been taking twice that and still keeping the principal in place (until 2022 that is).
But now things aren’t looking so great for investments , especially investments in the gilts market This diagram is taken from a wholesale investment article but the question it asks is as appropriate to IFAs and DIY drawdown management as to the posh “fiduciary management of DB pension schemes”.
Source Barnett Waddingham Fiduciary Management Review
Many DC default funds are constructed on the lines of DB plans (still assuming there is a guaranteed annuity to be bought. They invest like a DB fund – trying to hedge high inflation/interest rates through index linked and long dated fixed interest gilts. The result is the pain you may see when you review your DC pension pot(s)
But it isn’t all bad news. The cost of providing a pension from a pot is plummeting because of the decreasing cost of buying gilts and because the rate of increase in life expectancy is slowing and for some groups our life expectancy is actually falling.
So , as defined benefit pensions are finding out, it’s currently easier providing a pension – even if scheme assets have sunk like a stone.
Even if your pot is down – your potential pension could be up – and the good news is that your choices of pension are likely to get better.
Some people say that the long term return needed from pension scheme assets is 6% pa. This is the contractual accrual rate promoted by Con Keating.
Adrian Boulding, when talking about the kind of drawdown you can expect from CDC in decumulation is equivalent to the cost of a level annuity (which we’ve established is around 6%).
But I suspect that most prudent actuaries (as Adrian is) would stick with the rule of 4 right now and hold out the prospect of better indexation at a time of high inflation – on the basis that any investment strategy should see inflation plus returns as a target – if inflation/interest rates run at 6% + then there should be excess returns on a CDC or drawdown to give inflation linked protection to income.
So think the rule of 4 + inflation linked returns and you get to where most actuaries are with CDC rate targeting. I think that’s the best way of explaining CDC and the risk/reward trade off between investment and guaranteed income. And of course Adrian plans to provide you with the kind of lifetime income protection you expect from an annuity – the major advantage over drawdown.
In my opinion, a CDC pension looks a great halfway house between annuity and drawdown, offering more reward for risk taken and insurance against living too long. I can’t wait till these new CDC’s arrive and I’m keen to test them out using Agewage modelling.
We need easier ways to think about pensions. We need to be able to understand the pension rate relative to the mortgage rate and to work out what reward you could expect for investing rather than buying guarantees.
People need simple rules and journalists know it. That’s why we had so much noise yesterday when the banks announced 6% two year fixed rates.
If pensions are smart, they should be getting people to start thinking about pot to pension rates in the same way. We can think two or even five years into the future but we have trouble fixing anything much longer than that. We can think of the pensions arising from our pots with the certainty of our mortgages (many of which are variable).
In short, we can think of pensions as the opposite of mortgages and take some hope , if we are in later life, that while our housing costs are increasing, our pension power is too.
Not much consolation for those who have bought annuities prior to the current increases, but how many of us want a fixed rate for the rest of our lives? Some do – but most of us are prepared to accept a variable rate for the longer term- why is why drawdown and CDC will continue to be the mainstream of pension provision.
I recommend Barnett Waddingham’s Fiduciary Management Investment Performance Review – 2022 which can be freely downloaded here
Fiduciary Management (FM) is when trustees hand over the management of scheme assets and liabilities to a third party manager.
It is a great piece of work and tells us much about what actually happened to the assets within our defined benefit pension schemes in 2022.
By extension, since the principle of “hedging” which prevails in DB, is also prevalent in our DC workplace pensions, it explains what has happened to the money saved on people’s own accounts. Workplace pensions employ fiduciary management by structuring defaults (typically in the image of DB schemes). I will deal with the implications for DC in a seperate blog.
The principal message is that last year was like no other and that things will look back at it as a “pivot”
2022 was a pivotal year for UK defined benefit pension schemes, with rising yields reducing long-term funding target timeframes for many. This changed the objectives and needs of many trustee boards when looking to implement a fiduciary management framework.
While such a generalisation is valid, the survey looks beyond the general
It is more important than ever to consider scheme-specific analysis of performance, as there was huge variability resulting from the gilt volatility during the autumn of 2022, even within a single fiduciary manager.
The analysis is anonymised , no participating managers are identified in performance charts, the managers who participated are listed. The mandates offered to these fiduciary managers are to achieve various levels of return from assets compared with the increase or decrease in scheme liabilities.
The purple dots represent mandates where the trustees targeted the managers to achieve an aggressive target, the green target was middling and the blue targets were less demanding. The results show that by and large the less aggressive approaches resulted in similar returns and lower deviation from what the markets used returned, while the more aggressive approaches tended to see a greater spread of returns and “tracking error”.
But we can see enough outliers to know that some fiduciary managers went very wrong and a handful did very well.
But the vast majority of managers saw liabilities falling but assets falling much faster. This does not suggest that liability driven investment “worked”, indeed it shows that the pick up in scheme funding was down to a change in discount rates, not from there being more money in the schemes to pay pensions.
If you look at what actually happened to assets in pension schemes, the picture looks much worse.
The answer to Barnett Waddingham’s question (whether FMs could provide protection against falls in the markets) was in generality “no”. Even with a liability target reducing fast , assets did not manage to beat liabilities and this appears to be down to the hedging strategies employed.
And here, my understanding of what a fiduciary manager does, comes unstuck. My layman’s view is that a fiduciary should be able to manage the hedging of liabilities as well as the asset allocation.
With interest rates predicted to rise throughout 2022, why were the hedging strategies maintained broadly in line with previous years? Sure, a few managers cut loose from guidelines and were able to vary the level of hedging on an unconstrained basis, but it looks from the figures above that even the unconstrained mandates employed hedging,
My perception of fiduciary management was that by giving management of assets and liabilities to experts (at a fee) you were given an expectation that both assets and liabilities would be managed to a target. It seems to my untrained eye, that most fiduciary managers simply failed to take advantage of the massive head start that was given them by liabilities falling, In racing terms, liabilities were carrying several stones overweight but still beat better handicapped assets to the line. 
If you regard 2022 as a five furlong sprint, then liabilities won while carrying overweight
If you regard 2022 as part of a much longer 3 mile race then liabilities beat assets the vast majority of the time
The target boxes (the grey ones) are barely breached .
It would seem to me that over the past five years, fiduciary management – based on practice rather than theory, has failed the vast majority of schemes that have used it.
The only winners appear to be fiduciary managers which adopted, or were allowed to adopt, lower hedging of liabilities
Here you can see most schemes beating targets – even where the targets were high.
This leads Barnett Waddingham to some very simple conclusions – the “notable jump” is from a low dispersion of returns between FMs in 2021.
So 2022 was a pivotal year but most fiduciary mandates are still set to provide protection against interest rate falls. That protection went badly wrong in 2022 and so long as fiduciaries maintain hedging strategies, they will not be taking advantage in the ongoing rise of interest rates happening in 2023.
Hedging strategies in 2022 sometimes went wrong and clearly there were some train crashes among fiduciary managers when hedges were lost involuntarily. But for the most part, it looks to me as if the fiduciary managers – even when unconstrained by hedging guidelines, herded in 2022, missing one of their great opportunities , because they could not or would not reduce hedging in the first half of the year.
The report concludes that in 2022, fiduciary management didn’t work and by and large it hasn’t worked these past five years. If 2022 was a pivot, it will be interesting to see what change (if any) results.
I have another blog to write on this excellent report, it will come tomorrow and will look at issues of liquidity and of the impact DB thinking has had on DC schemes,
