Rising yields means UK pension deficits are finally shrinking again, according to several industry monitoring systems, but is the defined benefit sector spending too much time concentrating on shortfalls?
On Monday, PwC’s Skyval index revealed that the funding, accounting and buyout pension deficits eased by between £60bn and £90bn during October, depending on the measure used. The movement, however, does little to offset the £490bn increase in buyout deficits during 2016.
Hymans Robertson’s UK DB index showed a similar move in the buyout deficit, which now stands at £905bn. Meanwhile JLT Employee Benefits’ funding update showed an IAS 19 deficit of £447bn.
In the context of some risk of long-term sponsor failure, what investment and contribution strategies help improve the security of members’ benefits?
Calum Cooper, Hymans Robertson
The increase in deficits over the year was reflected in recent announcements by schemes and sponsors. Hospitality company Whitbread’s IAS 19 pension deficit jumped to £403.5m at September 1 2016, from £288.1m at March 3 2016.
Meanwhile BT Group’s scheme deficit was reported last week to have soared to £9.5bn from £6.2bn in June.
Own the process
But amid the slew of indices and funding updates there is a growing feeling among experts that the industry and the media have begun to focus too closely on monthly deficit movements.
Raj Mody, partner and global head of pensions at PwC, said scheme reaction to the latest Skyval figures should be very limited.
“The real question, that perhaps is not being asked enough but should be... asked, is, ‘What’s that number supposed to represent?’” he said.
Trustees “should be owning the process of deciding what numbers are relevant”, for example by understanding that gilt yields, which drive buyout valuations, do not influence pension liabilities as much as longevity or inflation.
He also urged schemes to consider insuring liabilities at the right price, to avoid “gradually turning into an annuity provider”.
A brighter perspective
There are also those who believe that the valuation techniques used by the various stakeholders in DB pensions do not accurately represent schemes' ability to pay all of the pensions due.
The First Actuarial Best estimate index, released last month, painted a very different picture of pension funding levels up to September this year. It showed UK schemes to be 133 per cent funded, their highest funding level ever.
The index uses an estimate of the returns available on the assets actually held by schemes to discount their liabilities, rather than the yield available on gilts or AA corporate bonds.
However, Henry Tapper, business development director at First Actuarial, said: “If we were saying that this is how schemes should set up their funding that would be a just criticism but we’re not.”
He continued: “What we want to do... is open the debate out so that people can see that it’s not all about buyouts.”
He pointed out that the Pensions Regulator does not explicitly require a mark-to-market valuation approach, and laid some of the blame for the industry’s focus on deficits on the rise of liability-driven investment.
Tapper argued that better DC provision should still be the focus of the private sector pensions industry, but pointed out the existence of the public sector as evidence that DB is not entirely finished: “It’s not impossible if the covenant’s there.”
Will you pay your benefits?
The importance of assessing DB viability through the lens of sponsor risk rather than solely by deficits was echoed by Calum Cooper, head of trustee DB at Hymans Robertson.
“[Deficits are] a helpful starting point but it doesn’t do anything more useful than tell you how far you have to travel,” he said.
PPF deficit figures presage hard times for funding and dividends
Following the Pension Protection Fund’s news of yet another record deficit in DB pensions, many schemes can expect to gear up for challenging funding negotiations, amid growing fears for company dividends.
Deficits and valuations give no prediction of how the situation may improve or deteriorate, he said, and neither do they give any indication of “how to fix the problem”.
Instead, he urged schemes to ask themselves, what, in the context of some risk of long-term sponsor failure, investment and contribution strategies help improve the security of members’ benefits.
Schemes could measure the security of their benefits, in relation to a government-backed pension, where Cooper said 100 pence to the pound was guaranteed. Investment gains or derisking might then improve this overall security ratio.
