What were the key takeaways from the Green Paper? Well, that probably depends which summary you read. While the headlines focused on the shock of potential changes, many in the industry actually saw this as a balanced and sensible account of the industry.
Let’s step back for a second - in a race to get column inches it’s easy to feed mainstream press with stats and headlines that would suggest the government has opened the floodgates for destroying the value of Defined Benefit pensions and allowing companies to change the promises made. The pensions industry could (and should) play a more constructive role in engaging with the real issues behind the challenge of DB pensions, in an open, balanced and mature way - not engage in a shrill grab for shock headlines.
Let’s not say everything is perfect in DB pensions; it clearly isn’t. But, there is evidence that with the right approach, tools and mindset, pension funds can navigate their way to stronger positions and increase member security.
Like many things, this isn’t black and white. The seriousness of the issues deserves a more detailed look. The paper is pretty clear in a number of areas. Pensions are a promise. They need to be honoured as such.
The paper talks about moral hazards and high burdens of proof. It's clear it's highly sceptical of allowing changes. It also says that most people - perhaps eight or nine out of 10 - are likely to get paid pensions in full under the system as it stands. Of course, that still leaves thousands of members in schemes which have affordability concerns and limited options of further support. But there is a safety net: the Pension Protection Fund is there to provide compensation to these members. Data from the Regulator suggest that companies can afford extra contributions on average, and with sensible investment strategies and risk management, most deficits will recover.
As an industry, we have a responsibility to encourage rational commentary on the future of DB, which tackles the real issues, not a focus on creating sensational headlines.
Let’s focus on how much, and what type of fuel the plane needs, what’s the best path to follow and how we get back on track if we fall behind. Not on insisting that the plane needs to ditch into the ocean immediately.
What we should be caring about is how their trustees are managing the promise they are there to uphold. Let’s engage with the real issues in DB and create a more productive narrative.
Let’s take a look at some of the alternative headlines that you probably won’t read...
1. Funding & Investment
Alternative headline: the Government doesn’t see evidence that asset allocation has been driven by inappropriate liability measures
The Government notes that:
It is to be expected that schemes will choose to match their liabilities more closely as they mature
They do not find evidence that asset allocation has been driven by inappropriate measures of liability value
They see the trade-off between reduced volatility (and investment returns) as being a rational one in some cases
They would like to understand further the process of trustee decision-making, particularly with respect to asset allocation and investment strategy, and what is driving the changes observed
What this could mean for pension funds: This highlights the need to have a clear log of investment decisions made, and the usefulness of a clear framework for articulating the rationale behind important strategic asset allocation decisions.
2. Employer Contributions and Affordability
Alternative headline: the Government sees evidence that there is not an affordability problem with DB pensions on average; some sponsors could afford to increase contributions.
The Government -
suggests that there is not an affordability problem on average and many sponsors could afford to increase contributions
Observed that there are some sponsors for whom the current level of DRCs may be unsustainable in the longer term
Quoted PPF long-term risk modelling that suggests, on aggregate, the funding position of all schemes combined should improve and reach around 85% of a buy-out basis by 2030. In the mean case, the modelling has some 600 more schemes entering the PPF by 2030, presenting a combined claim on the PPF of £3.5 billion. In the worst 5% of outcomes these figures could be 2,000 schemes and a £15 billion or more claim
Noted that it is not straightforward to identify a subset of schemes that would benefit from targeted intervention by TPR
Noted that there may be scope to tighten scheme funding periods in some situations, and expect quicker scheme valuations
Mentioned rationalising indexation and conditional indexation, noting the moral hazard implications associated with these
What this could mean for pension funds: this highlights the need for an integrated approach to managing the scheme (across investment, funding and covenant), in particular setting the investment strategy with regard to affordable levels of contributions, and understanding the trade-off between higher contributions, investment returns and the full funding date.
3. Member Protection
Alternative headline: the Government believes the majority of members will receive full benefits under the system as it currently stands.
The Government -
Believes that the majority of members will receive full benefits under the current system, and doesn’t see a crisis
Sees 11% of members as being in schemes with “affordability concerns” and a significant minority of members (around 5%) as being in schemes that are likely to have significant challenges in paying full benefits and uncertain recourse to further support (“stressed schemes”)
What this could mean for pension funds: this highlights the importance of understanding the corporate sponsor, whether or not the sponsor would currently be described as “stressed” and if not, what circumstances might lead it to become so. It highlights the importance of understanding the options, the available “levers” that trustees could pull in advance of these situations and the metrics to track to stay on top of it.
Alternative headline: the Government doesn’t want to interfere in consolidation
The Government -
Noted the possible benefits and challenges around consolidation and considered a few models
Expressed a preference for any solution to come from the industry and noted several potential consolidator products do exist
What this could mean for pension funds: it looks unlikely that schemes will be compelled to consolidate anytime soon, which may take a “worry” off the table for many trustees. Discussions on consolidation mainly focus around improving governance for schemes – it is worth taking another look at the governance process in place for your scheme and whether this is set up to enable the trustees to tackle important decisions in a timely way.
It's’ not particularly sexy headline writing. But what we need from government, industry commentators and journalists is a well-balanced debate. It’s clear there are challenges with the pension system, but let’s focus on having the balanced debate, and not rushing to create headlines.