PLSA Annual Conference 2016: Defined benefit pension schemes should look at whether they can stomach additional investment risk to minimise employer solvency risks, the chair of the DB Taskforce said on Thursday.
Speaking at the Pensions and Lifetime Savings Association’s annual conference in Liverpool, taskforce chair Ashok Gupta said a well-functioning DB sector is a “crucial driver for all parts of the UK economy”.
When you model the aggregate impact of schemes taking less investment risk, it does nothing to reduce risk to members’ benefits
Ashok Gupta, PLSA DB Taskforce
Gupta was speaking to launch the DB taskforce's interim report on the challenges facing DB schemes and their employers.
Risk to members' benefits
He also became the latest industry voice to suggest consolidation in the private DB sector to improve scale and governance. Pensions minister Richard Harrington and the Pensions Regulator have made similar suggestions recently.
Gupta said: “The taskforce has concluded that DB is not working as it should. The sector has problems, not problems you can understand just by looking at deficit numbers. We believe you have to start with what really matters, the risk to members’ benefits.”
The taskforce divided up the DB landscape into the Pensions Regulator’s four covenant groups. It found that among those with the strongest covenant, representing just under a quarter of liabilities, only about 6 per cent were expected to default over the next 30 years.
Of those schemes with sponsor covenants that are “tending to strong”, which represents 38 per cent of liabilities, 20 per cent are expected to default over the same period.
Weaker schemes have 50/50 chance of meeting liabilities
For the two groups with weak or tending to weak covenants, 65 per cent and 40 per cent of schemes respectively are expected to default over the next 30 years.
Gupta said: “If you take the last two groups, which represent 50 per cent of all liabilities, these schemes have a 50/50 likelihood of getting to solvency before the sponsor falls over. The risk is much higher than is generally understood. If you take a lower for longer scenario where you have sustained low interest rates, the risk is even higher.”
He warned that the pain for schemes comes from the volatility of deficits and the knock-on effect on companies’ financial results, which leads employers to take investment risk off the table.
“When you model the aggregate impact of schemes taking less investment risk, it does nothing to reduce risk to members’ benefits,” he said.
“If you take less investment risk you lock in the deficit, you bake in longer recovery period, you assume greater amounts of employer insolvency risk before the benefits are secured.”
He summarised the challenges faced by DB in four areas, which will form the basis for the taskforce’s work over the next six months:
The system is too fragmented, and the possibility of consolidation of schemes should be explored.
Scheme resolution is too inflexible, and the industry must be open to innovations in helping sponsors mitigate risk.
Scheme design is too rigid, flexibility should be introduced to ensure costs are shared better across members and generations
Risk management needs to be better, there are “clear inefficiencies” in capital allocation, schemes can bear more investment risk
Time is running out
Mike Nixon, head of pensions for aerospace and defence company Leonardo, said the challenge created by DB schemes was urgent, which can put pressure on decision-making.
“We have two defined benefit schemes, one of which is in surplus… but future service costs at the moment are spiralling through the roof,” he said.
Select committee inquiry: What should change to safeguard DB?
As the deadline for submitting views on defined benefit to the Work and Pensions Committee has passed, experts say there is a need for greater flexibility, potential benefit reductions and increased powers for the Pensions Regulator.
Dermot Courtier, head of group pensions at home improvement retailer Kingfisher, said there was a lack of understanding of the risks from pensioners within DB schemes, but also a lack of understanding from schemes who might be overestimating the amount of time they have before their scheme reaches maturity.
“We have a generation of people out there now who are either pensioners receiving a pension or deferred pensioners who don’t perceive that there is any risk because that’s the climate and background they’ve been brought up in,” he said.
“If you look at the cash flow implications to paying those pensions the maturity is really going to come over the next 10 to 15 years. It’s important we start today [to work on solutions] because we haven’t necessarily got as long as we thought.”
