(Spence & Partners latest blog for Pension Funds Online )
Last week I had the pleasure of chairing a session at the annual conference of the Association of Consulting Actuaries. I had high hopes for an interesting and interactive session, and was not disappointed. The slot was entitled “Current issues in corporate pensions” and you don’t need to work in the industry to know that we are currently experiencing some pretty momentous issues in the corporate pensions space.
The speakers had rather optimistically chosen six topics to cover in their hour-long slot. I say rather optimistically, as we only had time to cover about half of them. Listening to the presentation and the subsequent debate, I was struck by the sheer scale of the challenges that lie ahead for the unwary employer over the coming months.
It’s time to take action
It really is the case that better prepared companies have a real opportunity to create value, or prevent value from being eroded, by taking effective, targeted action now.
There have been some big headlines in the media recently on the topics we discussed. One that is particularly striking is the PPF 7800 index (A proxy for the aggregate funding level of “all” UK pension schemes) has gone from having a small surplus to a deficit of £368 Billion in little over a year. That’s a loss – over just 1 year – of more than £6,000 for every man, woman and child in the United Kingdom! These ever-worsening deficits are being driven by bond yields that continue to plummet (see my colleague Andrew Kitchen’s case study for more detail on how bond yields can impact a scheme ).
Where’s the bottom of the market?
Commentators have been calling the bottom of the market for some years now, and yet yields have continued to fall. At the time of writing, UK government index-linked gilt yields are negative, that is, investors are willing to lock in to a guaranteed loss, after inflation, over a long term time horizon. This phenomena isn’t peculiar to the UK – in Switzerland it’s even worse where the 10 year fixed interest nominal government bond is currently trading at -0.1%, so investors are basically paying for the privilege of lending their money to the Swiss government. Crazy times!
Surely (goes the familiar refrain) yields can’t fall any further?!? Maybe…maybe not, but at times like this I am reminded of the famous quotation attributed to John Maynard Keynes: “the market can remain irrational for longer than you can remain solvent”.
One thing is for sure – funding discussions aren’t getting any easier.
Corporates would benefit greatly from strong pension scheme governance: setting a robust strategy, having a strong and effective working relationship with the trustees, making good use of modern technology creating the opportunity to implement that strategy optimally, and directing focus and spend where it can really make a difference.
Perhaps even more momentous in the world of pensions is the rapidly approaching “pensions freedom day”. At the time of writing, we are little more than 50 days away from the introduction of “the most radical changes to pensions in almost a century”. Much has been written about the readiness (or otherwise) of the pensions industry to provide the new flexibilities that have been promised. Many occupational pension schemes will not be offering the freedoms for a variety of reasons, but with the media likely to go into overdrive over the next 50 days there is likely to be significant interest from the membership
Are we all ready for this?
There is a strong argument that these freedoms will prove to be good news for DB pension schemes (it’s about time!) as they create an opportunity for risk to be transferred off the balance sheet at attractive terms. A shot in the arm for liability management exercises perhaps? Conversely, the latest headline that has grabbed my eye was a suggestion that these changes could lead to a £100 Billion bill for sponsors of DB pension schemes, as half a million DB members take a transfer into DC schemes to take advantage of the new flexibilities.
Personally, I’m a little dubious around the assumptions behind this heroic statement, but it does highlight the uncertainty that is out there at the moment. April will certainly herald a big bang in the world of DC, but will it prove to be a damp squib for DB?
For what it’s worth, I suspect that the reality for DB will be somewhere in between, with the new flexibilities providing a valued option to a significant minority, and proactive employers taking the opportunity to design liability management options to benefit both themselves and the membership. One thing is for certain: there will undoubtedly be a lot of interest in these options and employers and trustees should be prepared.
Like last week’s session at the ACA, I could go on – there are many other issues that employers need to grapple with: DC governance, auto-enrolment, changes to accounting standards, the list goes on. With limited budgets (both in terms of time and money), governance is key. After working through what promises to be another momentous year, I wonder what will be the hot topics of discussion at the 2016 conference?