Posts Tagged ‘DB Pension’

Matt Masters

As we say goodbye to the 2010s and welcome the 2020s, we look back at some of the big themes that emerged in Defined Benefit (DB) pensions over the past decade.

Low interest rate environment

Much has been written about low interest rates, might they be here to stay and whether or not the UK is in the grip of a Japan-like environment? Regardless of the answers to these questions, it has certainly made the cost of securing pension income much more expensive, resulting in, amongst other things, significantly increased liabilities for final salary pension schemes.

This has led to an increasingly polarised position for DB schemes, with those who hedged interest rate risk early on now sitting relatively pretty, and those who did not now finding themselves continuing to stare at deficits, despite record contributions and one of the longest equity market bull runs in history.

While the low interest rate environment has led to a corresponding re-rating of asset prices, driving some of the unprecedented returns seen over the decade, perhaps more importantly it means lower expected returns looking forward. Consequently, pension schemes are having to keep their investment strategies under review, with many choosing to look at more esoteric investment classes and the merits of a fiduciary approach. 

A decade of returns

It was the decade of the equity bull market, with the US S&P 500 index up 28.9% in 2019, its best for some years, contributing to a 190% gain over the decade. This was led by stocks such as Netflix (up over 4,000%) and Apple (up over 850%).

Closer to home it was a decade of mixed performance. While the Total Return on the FTSE 100 was 104% (equating to an annualised return of around 7.4%), JD Sports, who weren’t even in the FTSE 100 index at the start of the decade, ended the period as the top performer, with £1,000 invested in January 2010 worth £33,700 at the end of December 2019.

By contrast, Tesco, with its accounting scandal, numerous profit warnings, and with the challenge from the German discounters, was the worst-performing FTSE 100 share over the decade, giving a negative total return of 21.6%. More generally, the banks and energy stocks largely seemed to have a tough time in the 2010s.

The rise of member options and de-risking

The number of DB schemes moving inexorably closer to the “end game” has increased substantially, with many putting in place strategies designed to move them into a position to fully secure all benefits as soon as reasonably possible.

While this may remain many years away for some, a focus on member options has come to the fore. Along with the now regulated incentive exercises, this can perhaps most clearly be seen by the change in options available at retirement. Beside the traditional retirement options of “pension; or tax-free cash sum and lower pension” are further choices, commonly a transfer value or partial transfer value, or an option to exchange pension increases for additional pension.

In addition, the buy-out market has continued to grow rapidly, with the second five years of the decade seeing some five times the level of activity from the first five years, with transactions peaking in 2019 at around £35bn. And, while the headlines suggest a focus on multi-billion pound deals, there remains competitive pricing for those smaller schemes who are genuinely ready to transact.

Pension freedoms

A look back over the past ten years wouldn’t be complete without mention of pension freedoms. The popularity of the member options mentioned above was turbocharged by George Osborne’s shock Budget announcement of 2014. Gone was the requirement to take an annuity with your Defined Contribution (DC) pot, replaced with the “freedom and choice” to do what you want with it, whether to buy the much talked about Lamborghini or not. 

With this change came a substantial increase in transfer value quotation requests, particularly from DB members over the age of 55 curious to explore their options. Indeed, this activity has led to a substantial increases in the amount transferred from DB schemes, to an annual amount in excess of £20bn. While seen as a win-win-win (a win for members, who are able to take greater control over their retirement planning; a win for pension schemes trustees, who see a consequent improvement in the funding position for their remaining members; and a win for pension scheme sponsors, who see a reduction in their buy-out liability), DB pension transfers could represent another “mis-selling scandal”, if not conducted properly.

Conclusion

While pensions are reassuringly long-term in nature, the rate of change in legislation and market developments can often seem to stand in stark contrast. The coming decade promises continued evolution and change, not least with a new Pensions Bill expected imminently, a “stronger, tougher regulator”, GMP equalisation to grapple with, the potential alignment of RPI with CPI, the possible rise of commercial consolidators and the implications of Brexit to come!

Hugh Nolan

Good News in Pensions

Christmas is allegedly the season to be jolly so it seems to be an appropriate time of year to remember the good things about the UK pension scene. There are a lot of them!

Firstly, there are currently well over 10 million members of Defined Benefit (DB) schemes in the UK private sector. This includes 1.3 million people who are still accruing benefits, not to mention all those in the public sector. The private sector is currently paying over 4 million pensions regularly and in full. Despite the impact of the credit crunch, low interest rates and increased longevity, these DB schemes are now estimated to be funded at 73% of the full cost of buying guaranteed benefits from an insurance company, up from 60% in 2006.

There are still inevitably some corporate failures where members have to rely on the Pension Protection Fund (PPF) for their benefits. There are less than 250,000 who have had to do so since the PPF started in 2005 though and their payments from the PPF are well-protected, with £6.7 billion reserves and an estimated probability of 91% of meeting their funding target. The PPF is funded by a levy on the other schemes and the total levy fell last year to £541 million, some way below the £725 million that the PPF was able to pay out. That’s a wonderful improvement from the bad old days when members could lose their pensions entirely if their employer went bust.

On the Defined Contribution (DC) side, auto-enrolment has been a huge success too. The statistics at the end of November 2018 showed that 9,958,000 people have been auto-enrolled into pension schemes, which is a massive number of new savers who won’t be solely reliant on the State pension when they retire. That’s particularly important when the State pension itself is under huge pressure due to an ageing population and austerity and it again shows the advantages of personal pension saving.

Finally, the pension industry keeps trying to improve the regulatory landscape to get the best results. Successive Governments have decimated DB schemes with excessive regulation and, more significantly, by imposing additional financial obligations on schemes retrospectively. We have been lobbying for years for more flexibility and it’s great to see that the Royal Mail and Communications Workers Union have got support from the DWP and politicians to try a new Collective DC arrangement. This isn’t a magical solution to the pensions issue but it has a lot of merit and it’s great to see the industry trying to make the best of a very muddled legislative background.

We’re very proud at Spence to be part of the industry that has delivered these opportunities for millions of people to have a better quality of retirement. The real stars of the industry though are still the sponsoring employers who have paid most of the money needed over the years for their staff to get decent pensions. We also need to recognise the diligent efforts and hard work from trustees, who give up their time and wrestle with the complexities of pension regulations to get the best outcomes for their schemes and members.

Well done everyone and a Merry Christmas to you all.

David Davison

The more I read about defined benefit (DB) consolidation, the more it appears to have a key parallel to Brexit, namely: everyone seems to have a different expectation of the outcome.

The DWP’s White Paper “Protecting Defined Benefit Schemes” was published in March and followed up last year’s Green Paper with further proposals on the benefits of consolidation.

There are multiple consolidation options. Each will have a different impact and will be complicated to achieve.

The suggestion is that bigger is better. Having larger schemes reduces cost and improves governance. Interestingly, however, the 2017 Purple Book suggests that smaller schemes (i.e. those with less than 100 members) are on average better funded than those with more members.

So, in considering consolidation, what options are possible, what are their potential benefits and what might be the associated considerations?

Investment consolidation

The potential to consolidate investments seems relatively simple, can reduce costs and provide schemes with access to a greater level of investment choice.

Access to investment platforms can provide cost and administrative benefits even without wholesale changes to underlying governance or administration.

Governance consolidation

Consolidating governance, for example, in the form of sole ‘professional’ trusteeship also seems to present schemes with a straight-forward path to governance improvements and can be achieved without upheaval to the schemes’ delivery services.

Going beyond the above there is further potential, but the benefit improvements are much less certain based upon the specific circumstances of each scheme and employer.

Operational consolidation

There may be operational opportunities to merge key scheme services such as administration and actuarial.

It’s far from clear cut, however, that such a move will result in cost savings.

There is little evidence that the provision of services within a DB Master Trust are provided at a materially lower cost unless some form of benefit consolidation can be achieved.

In addition, the likely scheme time horizon will have a huge bearing on the cost effectiveness of any move given the inevitable set-up costs of a service change. If, for example, the time horizon to buyout is within 5-10 years then annual savings may not outweigh initial transition costs.

Any move to a DB Master Trust must be reviewed in terms of flexibility. Such a move will require a scheme to fit within the DB Master Trust model where any pricing improvements which can be achieved are done so via some form of standardisation.

The timing of valuations or the approach to administration may not be something that suits all schemes or employers.

What is the Master Trust approach to employer covenant, member communication and benefit options and is any approach outside the norm likely to incur additional costs which may negate any savings?

This will be an important initial consideration as in my experience these schemes are much easier to join than they are to exit.

Benefit consolidation

This is even more problematic.

Converting one scheme benefit basis to another has long been fraught with difficulty given that ultimately a guarantee will have to be provided that members will be no worse off.

This will undoubtedly result in up-front costs that again have to be considered against any savings which can be made in future.

There have been calls for Government to standardise benefits to make consolidation easier, but it remains to be seen how this can be achieved.

Ultimately a Scheme Actuary will have to sign-off any benefit conversion to confirm that the change does not detrimentally impact on members’ accrued benefits, which is far from an easy hurdle to get over.

It is also difficult to envisage how consolidation can happen for schemes with unequal funding levels, as trustees would surely seek a “levelling-up” of funding. This has been an issue which has undoubtedly slowed the pace of consolidation in Local Government Pension Schemes (LGPS).

There must also be a concern that close links to key personnel in a scheme sponsor who can provide valuable insight from an employer covenant and operational perspective could be lost through consolidation.

Are ‘Superfunds’ the answer?

There have been proposals that a middle way between own-scheme funding and buying-out with an insurer may be possible.

This would be via what have become known as ‘Superfunds’ which would consolidate scheme benefits from multiple schemes. The suggestion is that sponsors would benefit from lower costs than that required to fund a buyout.

Proponents have been quick to highlight that any transfer in to Superfunds would need to be fully assessed by Trustees as being in members’ interests and that any agreement is likely to result in accelerated employer contributions over those paid under a funding plan in order to gain access.

An initial entrant to the market has suggested that revised legislation is not required as their scheme is just the same as any other occupational pension scheme and could run under existing regulation.

This, however, differs from proposals put forward by the Pensions and Lifetime Savings Association (PLSA) where it was expected revisions to the regulatory framework would be required.

Clearly we are at a very early stage in terms of this potential solution and it is likely to evolve over the coming months. Undoubtedly questions remain over this approach, particularly around the break in the link to the sponsoring employer and therefore the strength of the employer debt security.

Industry unconvinced by consolidation

The Association of Consulting Actuaries’ Pensions Trends Survey 2017 suggested that only 16% of sponsors would consider consolidation and only 32% thought that potential cost savings were real.

That would seem to suggest there are real concerns about how successful any consolidation might be and a high level of scepticism that promised improvements can be achieved.

It is interesting that LGPS schemes where the benefit basis is the same have primarily gone for investment consolidation. This may well be a first step, but where funds have merged for delivery services the impact in the end-user experience has been patchy.

There are undoubtedly efficiencies and opportunities for improved investment and governance available through some form of consolidation, however, the extent will be very much based on individual circumstances and requirements.

Those in favour of much greater reform certainly have a lot of convincing to do.

This article originally appeared in CA Today on the ICAS website here – on the 19th May

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