Is there a DB pensions crisis?

No, according to the Pensions Regulator in their contribution to the Department for Work and Pensions (DWP) Green Paper on “Security and Sustainability in Defined Benefit Pension Schemes”, published at the end of February 2017.

“The available evidence does not appear to support the view that these pensions are generally unaffordable for employers. While DB pensions are more expensive than they were when they were originally set up, many employers could clear their pension deficit if required.”
“…..the evidence suggests that there is no single or immediate crisis in DB funding for the system as a whole.”

So there you have it, Keep calm and carry on! Mmm, I’m not so sure about that.

Looking at the 50 or so DB pension schemes of TDC’s clients, half a dozen are in surplus or close to being fully funded and 4 to 5 could be described as in a distressed state of funding. All the rest, about 80% of our clients’ DB schemes, have a sizable deficit that will require many years of significant deficit reduction contributions (DRCs) to remove. The debate on whether there is or is not a DB pensions crisis is really a discussion on how long employers will have to continue paying high DRCs.

The Green Paper considers the pros and cons of various changes that could be made to the funding, investments and governance of DB schemes but does not propose any firm solutions to current problems. The issues being considered are covered under four broad headings;

  • Funding and investment
  • Employer contributions and affordability
  • Member protection
  • Consolidation of schemes

My views on the key issues in each section are as follows.

Funding and investment

“…it is not clear that in general discount rates being used are overly pessimistic, and that there is not strong evidence to demonstrate a systematic issue with the current flexibilities available.”
I do believe the current funding framework is fairly flexible and can accommodate the range of funding issues being faced by small schemes. However, the derivation of the discount rate in a very low yield environment can be problematical when actuaries propose a “gilts plus” basis that rigidly follows the declining yield on risk free assets. In an up and coming blog, one of a series on issues covered by this Green Paper, I will look at how discount rates can be derived, in the context of Tranche 12 valuations with a March or April 2017 valuation effective date.

I agree that scheme valuations should be completed in a nine month period rather than the current 15 month timescale.

With regard to investment strategies and asset allocations, there is scope for trustees to receive more advice and guidance on this critical driver of scheme performance. There are examples of schemes where the trustees do not commit the time or have the skills to fully consider their investment strategy, and sub-optimal investment decisions can be the result. A succinct Integrated Risk Management (IRM) framework can greatly assist both the trustees and sponsoring employer understand the key funding and investment factors of their scheme.

Employer contributions and affordability

“We are not persuaded that there is a general affordability problem for the majority of employers running a DB scheme.”

Affordability ranges from no DRCs being required as the scheme is in surplus to affordable DRCs being only 2% of the calculated deficit. For genuinely stressed schemes, or is that distressed schemes, further flexibility to ease the pressure on the sponsoring employer should be made available. An obvious solution involves members’ benefits being reduced, perhaps over a temporary period, possibly by removing indexation or using CPI rather than RPI inflation. However,
“The Government does not think the evidence is strong enough to suggest that indexation should be abandoned or reduced across the board.”
“The Government believes that DB pensions are hard promises…”

My future blog, entitled “The First Cut is the Deepest” will describe a framework for identifying stressed schemes and applying temporary reductions to members’ benefits.

Member protection

This section of the Green Paper looks at possible additional powers for the Pensions Regulator, perhaps to avoid a repeat of the criticism of its role in the BHS scandal. Thankfully, a mandatory requirement for clearance for all corporate transactions is not thought to be appropriate.

There is a suggestion that the Regulator will have a more proactive role in scheme funding, particularly for stressed schemes. I hope that greater involvement by the Regulator will not create onerous and costly requirements for trustees and employers.

Consolidation of schemes

Perhaps it is no surprise that TDC is firmly against the concept of consolidation of small schemes. Yes, our business focuses on the provision of administration and actuarial services to trustees and employers with small and medium sized pension schemes. But the problem of consolidation is that the so called benefits of bringing together dozens or hundreds of small schemes in a DB master trust arrangement (lower costs, greater investment returns, improved governance) are unlikely to be realised.

Cost effective management of (closed) stand alone DB schemes is available from specialist consultancies and the use of professional trustees brings the required high standards of governance. Having access to the full range of asset classes is less important than putting in place an investment strategy that is consistent with any funding and covenant constraints.

Thankfully the Green Paper states “Compulsory consolidation is not thought to be a proportionate response.” However, the DWP is looking for the pensions industry to provide innovative “superfund” vehicles. The final report of the PLSA’s DB Taskforce, published last month, proposes the creation of superfunds that not only pool services and assets but consolidate liabilities as well.

I will shortly dedicate my next blog to explain why I think consolidation of small schemes is not required.

The DWP is asking for views on the subjects covered by the Green Paper by 14 May 2017. As there are no proposals to fundamentally change the current funding and regulatory regime for DB pension schemes, I anticipate a series of less significant revisions and adjustments being effected over the next couple of years.