SHAPS – a completely different definition of ‘marginal’

David Davison

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It is amazing how quickly time flies. It seems like only yesterday that Scottish Housing Associations were absorbing the bad news about the funding position of the Scottish Housing Associations’ Pension Scheme (SHAPS) in late 2013 and getting used to their new higher contributions from 2014. Associations have now just received communication containing the initial results of the September 2015 valuation.

The great news, apparently, is that the ongoing funding deficit has reduced from £304m to £198m, representing an improvement in the funding position from 56% to 76%. The improvement has been attributed to a combination of investment performance, additional contributions and other experience. If this information is confirmed in the formal valuation it could all result in a reduction of the term of the deficit contributions of about five and a half years. This is all great news, isn’t it?

For those of you of an accepting nature then it is job done, issue parked and you would appear to be able to continue to fill your boots with defined benefit accrual without material concerns.  However, if you are of a slightly more sceptical disposition, perhaps built up over many years experience, you may want to dig a little deeper…

It is initially interesting to consider the backdrop of the results. The scheme ‘de-risked’ at the last valuation, investing in lower risk stocks which might have expected a lower return. The results demonstrate that the asset performance has been positive, so credit where credit is due on that front. The difficulty for the Scheme is that the investment return consistently needs to run very fast to keep up with the ever increasing level of liabilities and some difficult underlying membership and longevity issues that the scheme has to deal with, but more on that later.

On the liability side, the position is a bit more intriguing, and more difficult to assess, as unfortunately the report does not incorporate any of the underlying assumptions actually used (the assumptions were disclosed in the Trust’s presentation to employers in November 2015). The report suggests that over the period the value of the liabilities has increased by £112m from £698m to £790m, before changes in market conditions are allowed for.

In the table below I have shown the key changes in assumptions on a “like for like” basis, and their impact on the value of the liabilities.

SHAPS Table

So, we add £160 million to the £790 million to get an overall value of the liabilities of £950 million – easy, right?   No, this is where things take a sharp turn in a different direction.

Instead of adopting “like for like” assumptions, the Trust have decided that the Scheme no longer needs to hold as much assets to pay future benefits.

The report gives some explanation around this issue:-
“The fall in government bond yields between the 2012 and 2015 valuations together with the low interest rates, has led to a lower rate of discount adopted to calculate the present value of the future payments. This results in a higher value of liabilities.” Ah, so my assumption was right!

“However, the Committee has adopted valuation assumptions reflecting its overall view of the aggregate financial strength (the covenant) of the SHAPS employers. The assessment permitted the Committee to view with more confidence the long-term strength of the sector and therefore apply marginally less prudence to the assumption that investment returns would be realised.” Ah, so in other words we are going to change our approach and adopt a lower funding target (by assuming that investment returns are going to be relatively higher than before)…

OK, I accept that assumptions can change and this will alter the value of the liabilities.  Where I really, really struggle is with the claim that the Trust is applying “marginally less prudence”.  Marginally less – what 1%, 2% maybe?  No, the Trust is applying about 15% less prudence.  I don’t need to go scurrying for the latest Oxford English to realise that a 15% change is hardly marginal.

Since I first became involved in this Scheme, I have been worried about the lack of prudence in the actuarial assumptions.  The 2012 valuation increased the prudence in the assumptions and I welcomed this as a move in the right direction.  The 2015 results smack of a move back to the bad old days of crossing fingers and hoping everything will be OK.  This is how the Scheme got into such trouble in the first place and I urge the Trust to reconsider, even if it means participants paying deficit contributions for a longer period.

As a scheme sponsor, what I would want to know is, if we started with the funding principles agreed at the 2012 valuation, with no change in method, what would the results have been (i.e. confirmation of something around my £960 million figure)? I would also want to see the figures on a solvency basis, as this would provide for a more consistent and objective assessment of the Scheme’s liabilities.

From an employer future cost perspective I would also want to understand the likely impact of the increasing move towards defined contribution for employers and employees, likely to result in an increased average age of DB members. What sort of impact might this have on scheme funding over time?

Employers should also be considering the likely impact on their costs and liabilities of:

  1. the introduction of revised state benefits resulting in the abolition of contracting-out from 31 March 2016. The removal of these NI deductions will increase net contribution costs by 1.4% of band earnings for employees and 3.4% for employers.
  2. the proposed changes to the living wage could also have a negative impact on the funding costs for the scheme as lower earners salaries may increase more rapidly than projected and even employers who have made the move to defined contribution are not immune to this as the Scheme retains the link to future salary for active employees.
  3. the disclosure of these deficit amounts on balance sheet for the first time in 2016 which will make the issue much more visible than previously was the case.

Once all this information is available then its relevance to each employer can be assessed and organisations can decide if they’re happy with their future strategy or if some greater clarity is required.

David Davison

Post by David Davison

Specialist consultant on pensions strategy for corporate, public sector and not for profit employers

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