The long-term decline and demise of DB pensions has been a major area of anger and frustration for many (including the authors). Debates are heated and often decline into the acrimonious.
However, much of this is not about pensions, but systems of beliefs about economics — for example, are markets efficient? — that create a dividing line between sides.
While the factions spend hours debating their somewhat irreconcilable viewpoints, another aspect of the regulatory regime is rarely discussed: how much is this costing us?
Self-sufficiency, the elimination of dependency upon the sponsor employer, is the new objective. It will require further funding on a massive scale
Modern defined benefit pensions regulation began with the Pensions Act 1995, when DB was the dominant form of occupational pensions, and taxation of surpluses was an issue.
The years since have seen masses of further regulation. The volume of pages of pensions regulation and legislation has risen by staggering amounts — from 3,000 pages in 1990, to 160,000 pages in 2016 and is now guesstimated to exceed 180,000 pages.
These successive pieces of regulation have proved inordinately costly to corporate sponsors. In the period since 2009, for which consistent statistics are available, £160bn in special contributions alone have been paid into deficit recovery, with no discernible impacts on deficits or member security. Taxpayers have borne about £30bn of this cost.
Rear-view mirrors
The introduction of the Pensions Act 2004, and its subsequent scheme-funding regulations, provided a new regulatory architecture, creating a new Pensions Regulator and the Pension Protection Fund.
Under this regime, section 75 liabilities became full buyout for both solvent and insolvent companies at wind-up, removing the equitable treatment of the other creditors of an insolvent company.
The scheme-funding requirement is based on ‘technical provisions’. These are upwardly biased estimates of liabilities via discount rates that are erroneously based on market yields and asset prices.
The result is that as interest rates have fallen due to monetary policy and inflation targeting, and then pushed through the floor by successive rounds of quantitative easing, liability valuations — but not pensions themselves — have exploded.
In response, schemes have progressively followed defensive asset-allocation strategies such as liability-driven investing, which manages measurement, not risk.
Throughout this period, the regulator’s emphasis has been one of ever more funding, motivated in part by its statutory requirement to protect the PPF.
In looking at how we arrived here and our critique of the colossal costs of the regime, we could be criticised as having a rear-view mirror to pick holes in what was well-meaning regulation. And who could have predicted the outrageous largesse of central banks to encourage moral hazard, maintain property prices, and keep zombie companies afloat.
However, the game of discount rates was clearly identified in the Myners Review in 2001 in relation to the minimum funding requirement: “For that reason, it does not agree with proposals for a standardised test, even if it were only applied to some portion of the benefits. This would still create artificial incentives to match the assets used to generate the discount rate for the liabilities.”
Past costs are guide to future costs
In looking at the regulator’s proposed DB funding code, we have the experience of the past 15 years or so, and the significant economic consequences of not understanding the discount rate game — around £160bn in special contributions at a cost to the exchequer of circa £30bn.
Simply put, the new funding code is all concerned with management of the endgame — a world where DB is dead in all but a few places. Self-sufficiency, the elimination of dependency upon the sponsor employer, is the new objective. It will require further funding on a massive scale.
The PPF currently reports a total deficit (for schemes in deficit) to the section 179 value of £306.4bn, and that is likely to be an underestimate of complete self-sufficiency.
Crucially, this money comes from companies — it is the redirection of money from the real economy to the financial economy via the purchase of ‘matching assets’.
Further funding on this scale would be an economic and fiscal disaster, perhaps the least of which would be the loss of £60bn in corporate tax revenues.
Iain Clacher is an associate professor in accounting and finance, pro dean for international at Leeds University Business School, and Con Keating is head of research at BrightonRock Group
