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
Estimates from Hymans Robertson show that a move from RPI to CPI would take away around £20,000 in benefits over an average DB scheme member’s life. Moving to statutory indexation only would increase this loss to members substantially.
In other areas benefits passed on to a spouse or children can be eroded or even removed. Even some of the best schemes only provide maximum spousal pension of 66% - most are around 50% of what the member receives..In a lot of cases children get zero.
#Diageo – has recently agreed proposals with the Unions to continue it’s DB scheme but change the benefits to 1/70th accrual rate (from 1/60), career average earnings (From final salary) plus 8% contributions from it’s members from April 2018. The fear factor was deftly outlined; in a joint statement outlining the updated proposal in November last year, GMB, Unite and Diageo said of the future of the scheme: “We can never give complete guarantees on the future of any pension scheme. However, there are currently no reasons for the company to close the DLP to future accrual as the costs of this scheme are comparable to the costs of the new DPP and the risk of this cost increasing is capped – the cost and risk of the DLP is therefore manageable.
#Glaxo Smith Kline took an altogether different route in 2012 when it slashed benefits to thousand of it’s members by capping future pensionable pay increases to just 2% pa. Why did it do this? Because despite putting 2 Billion into it’s scheme between 2006-2011 it’s liabilities hardly changed.
But the worst kind of incrementalism is the ‘frozen’ pension. A huge number of employees leave for pastures new and do not take their pensions with them. They simply leave their pensions with the company – unaware that benefits can and do change. In the last few years witness Ford, Goodyear and the Archdiocese of Philadelphia groups all freezing certain pension plans thus preventing any further increase in benefits by those groups affected.
What’s the solution
To misquote Bill Clinton – “It’s the baby boom stupid”!
However employers are charging for the exit and offering some individuals enormous transfer values in order to buy out this liability.
This should not be undertaken lightly – the member does surrender a guaranteed pension remember – but some of the valuations we have seen have been the equivalent of 20-30 years worth of pension income ( source FTSE 100 member 2017).
But the biggest change in my view is control. You can decide what risks you want to take with your money and you don’t even need to leave the confines of the UK regulatory protection. Plus you can leave something behind for your children or grandchildren.
Let me finish with a true story. In 1991 I was working as an Independent IFA in Piccadilly in London.
I was approached by an investigative journalist from the Mirror newspaper (Maxwell’s flagship newspaper) about the possibility of moving her DB scheme assets.
In those days this was nigh on impossible due to the regulator taking a very dim view of swapping defined benefits for a variable return. My firm had never done one.
My first thought was that this was a way to get me to incriminate myself and provide another expose of the woes of our industry so I declined.
A week later she came back to me with two of her colleagues who all wanted the same thing and implored me to help.
To cut a very long story short I finally managed to persuade my boss to let me look at this and see if we should move her money away from Maxwell.
The answer once we had done the analysis was an emphatic….. no!. In those days Gilt yields were 6 times what they are today so the maths simply did not work.
I explained all this to her but she insisted that she would “sign anything” to get her pension fund away from the group. And here is where financial advice isn’t just about the numbers. Now I had both a professional and a moral dilemma. The figures said no but if I didn’t do this I was declining the client’s obvious wishes and she had done her own ‘investigation’ into the Mirror funds. Was there an intangible benefit – like control or security - that outweighed the mathematics? My partner in business at the time called the situation toxic and ripe with litigation possibilities.
It took me nearly 6 months of sheer persistence to get the money including the infamous the “cheques in the post” delay. 7 days after she transferred her funds Robert Maxwell threw himself off his yacht and the biggest pension fraud in history was exposed.
I received a case of champagne.
In the aftermath where thousands of mirror workers lost their pensions The Mirror DB schemes still exists as Trinity Mirror…or does it; The mirror group itself has a market capitalization of $296 million with a mere pension deficit of $426 million…that’s 30 years worth of shareholder dividends. But like the government paper says in true DoubleSpeak - there really is nothing to worry about.
Author: Russell Stagg
UK Green paper – Security and sustainability in Defined Benefit Schemes Feb 2017
Purple Book – Pension Protection Fund 2016
Citywire – Jan 3 2017
Telegraph – Feb 5 2011