Challenges and transformations of pension schemes
I joined the pensions industry in 2009, just after the credit crunch. At this point, gilt yields were around 5% p.a., and they steadily fell over the next 15 years until they reached lows of around 0.5% p.a. when the COVID-19 pandemic hit. A 4.5% p.a. fall in gilt yields, all other things being equal, doubles pension scheme liabilities.
In 2009, the industry was also concerned about life expectancy, which had been steadily rising. Improvements in life expectancy had also been increasing year on year.
Falls in gilt yields and increases in life expectancy both had the impact of increasing funding costs from previous estimates, creating scheme deficits, and placing pressure on sponsors.
I am told that prior to when I joined the industry, in the late 1990s, surpluses were common and benefit augmentations, contribution holidays and refunds were the norm.
My full pensions career, bar the last 12-18 months, has been focussed on schemes in deficit. Schemes were primarily in deficit because the cost of providing the benefits was higher than expected, due to lower than expected investment returns (especially post 2008), and higher life expectancy, among other factors.
Signs of Change
It feels like we are now entering a new world, perhaps more akin to the late 1990s. The September 2022 gilts crisis required a Government intervention to restore orderly market conditions. A fallout from this was that gilt yields spiked, and they are now at the levels seen at the beginning of my career. Life expectancy is also falling, with post COVID life expectancy lower than previously thought. Funding levels have improved dramatically, and there is definitely a shift in mindset on what this means for the economy, employers, and defined benefit pension scheme members. In a world where insurance buyout has been king, alternative options are now being considered, with run on and surplus extraction a realistic option.
The Work and Pensions Committee issued its report on Defined Benefit Pension Schemes in March 2024 and the recommendations support this shift in mindset. There are a number of areas covered by the report, but I found the following interesting:
- Changing the objective of TPR to no longer protect the PPF, but protect members’ current and future benefits, with an aim to encourage defined benefit pension schemes to continue to provide benefits;
- A recognition that pension scheme investments could help the UK economy, if invested in the UK, again, supporting the ‘run on’ argument but from an alternative view;
- Supporting surplus extraction and the ability of an employer to effectively use the pension scheme as an asset (provided member benefits remain safe);
- PPF compensation – reducing the levy to zero or improving compensation levels to use up some of the £12 billion reserves currently held.
I can’t help but wonder if there is a risk that we repeat some mistakes of the past. We have been through benefit augmentations, contribution holidays and surplus extraction in the highs of the 90s. We then hit the lows of the 2010s – what if the same happens again?
Ensuring Stability and Security
As an advisor, one of my biggest worries is always ‘unknown unknowns’. I have seen three ‘one in 20 year’ events in my career. I would hope that we have learned from the mistakes of the past and any new flexibilities are introduced and used in a well thought out way. A way that manages risk and protects the security of member benefits, whilst reducing some of the burden of cost/inflexibility that employers funding defined benefit pension schemes currently face. Additional suggestions in the paper aim to increase member security through mandatory accreditations for trustees and end game planning, which may help with this.
The paper makes a number of recommendations for DWP, TPR and Government to consider so it’s a ‘wait and see’ to see if any of the suggestions come to fruition.