Sometimes the life of a financial adviser is very dry. The recent release of the Green Paper on the Security and Sustainability in Defined Benefit Schemes provides one such example but lets take a closer look. As a maverick I view all things with the view of an analyst plus a healthy dose of skepticism and a quick wink to 1984.
First an admission. I am a true advocate of pension control. My father lost his entire pension in a corporate takeover 22 years ago. That can’t happen now because legislation has made it illegal , but it colours my advice – you only get one go to save for your retirement. There are no second chances.
First what is a DB scheme? This is where the scheme promises to pay a pre-determined amount of pension to it’s members based on their salary and years of contribution, independent of investment returns.
As you can see DB schemes assets are considerable – 75% of the GDP of the country!
Why has the government written this paper and what are it’s conclusions?
There has been concern over the last few years at the sustainability of DB schemes. As a professional financial adviser for the last 25 years I have witnessed an almost 100% withdrawal of DB schemes to new members. In fact the paper states that only 13% of schemes were open to new members compared to 43% just 10 years ago.
However of that 13% this includes Hybrid schemes ie one that holds DB members and defined contribution members as well. Unravelled this means the company has simply stopped offering DB schemes but continue to honour its past obligations to DB members. To my knowledge I can only think of a single employer offering a DB scheme to new members – Rolls Royce. There must be others but you take the point; they are extremely rare and getting rarer.
This begs the question why? And the answer is simple – the ongoing liability and contributions required to sustain a DB pension are simply too great. Secondly and more insidious is the arrival of the Pension Protection Fund in 2005. A government regulator charged with paying compensation to members of defunct schemes. A very laudable aim with a single fundamental flaw… it has no budget.
So there’s the first Oxymoron – a safety fund with no funds.
So in practice this means DB schemes are now treated as a single asset class by the government. If one fails the others are levied in order to help the fallen ones.
It is no surprise that if you look at all the statistics from 2005 to today they show a uniform flight from DB schemes both by employers and by savvy members.
But first there are a few interesting facts about this paper and what it reveals
1. The average pension payout is 7,000GBP pa- yes just $134 per week or $12 more than the basic state pension
2. The single biggest risk to the members of these schemes is the collapse of the sponsoring employer. Here you are at the mercy of the PPF whose stated objective is to levy DB schemes in the event of a failure. To repeat - the good ones help support the unsustainable ones.
3. There was a clear view that experiences differ from scheme to scheme, that some schemes and employers are struggling, and that some changes may be beneficial. However there was no consensus on whether or how to adjust the current balance between protecting members and supporting employers.
4. The no of scheme members that have applied to the Pension protection fund
Is 120,000 and their average payout is around 60% of the average DB scheme payout at 4,000 per member. But again the figures mask things. In the 2016 BHS scheme collapse a 55 year old retiring on $37,000 a year only received $28,295 or 25% less. Retirees on higher pensions get hit disproportionately. Just take a moment and imagine the rest of your life on
Just two thirds of what you were promised.
What is disturbing about this report is the obfuscation about tackling one of the largest issues in the country. In a remarkable 1984 newspeak doubletalk
We have also considered comments made that schemes are not using the available flexibilities when deciding what assumptions to use about future investment growth, and that this is leading to scheme deficits being overstated.
So its not a funding deficit simply because the employer is not using the correct numbers in it’s assumptions. Your government knows better. Lets take a detailed view.
What this shows is that whilst life expectancy is increasing for retirees ( so increasing ongoing liabitlies for pension schemes) the ability to fund them through annuity /gilt purchase has fallen by over 75%.
However as anyone knows there are lies, lies and dammned statistics and the Governments own calculation in 1983 is shown up as wildly inaccurate.
In 2014 they predicted life expectancy at age 65 to be 15.2 years; the ACTUAL figure was 21 years which was nearly 40% higher than predicted. If they can get something that fundamental that incorrect it makes you wonder about their statement that there is no systemic funding issue of DB schemes. Yet DB schemes continue to be closed by employers.
Again, to use independent figures ,an increase in longevity of just 2 years raises schemes liabilities by 6.5% or 108 Billion GBP- that’s 5% of GDP. These are massive numbers.
How do employers fund their pensions?
According to an OECD report, UK pension funds’ real 4-year and 9-year geometric average annual returns were 8.4% and 6.5% respectively. But this includes all the non DB schemes. If we look at DB schemes asset allocation a totally different picture emerges. As you can see from below the average Bond/Fixed Interest content of a DB scheme has risen from 26% to 50% in just 10 years
This implies a much lower return in the future for DB schemes. In fact the Purple Book (an independent study of Pension liabilities) outlines what this means in terms of performance; a 0.1% reduction in gilt yields raises liabilities by 2.5% but increases assets by just 0.6% whilst a 2.5% rise in equity markets raises scheme assets by a mere 0.7%. Effectively all schemes are thus asymmetrically leveraged the wrong way. It can only get worse as the baby boom generation starts to retire as there will be more pensioners calling upon scheme assets thus pushing up the bond ratio and reducing the ability to recover deficits through equity exposure.
What we have seen is a form of creeping erosion of DB scheme benefits.
The movement away from increasing benefits in line with RPI to Consumer Index for instance quote