Interest Rates fall. What should Pension Funds do? NOTHING !!!

The unprecedented low levels of interest rates have had only one significant effect on private sector DB pensions. That is on liabilities. Government (BOE) interest rates determine Gilt Yields which in term determine the discount rate used in liability calculations.

The Discount Rate is an assumption. Liabilities extend forward for decades (30/40 years) and nobody can forecast what level of interest rate will apply. It is reasonable to assume that at some point rates will revert to traditional norms. That is to say significantly higher than at present. So using current rates substantially overstates a fund's liabilities.

The prudent Fund Manager will not panic and certainly not seek sponsor support to boost assets to match liabilities which by any rational analysis are significantly overstated. Better to run for a time with a negative funding ratio than to send good money chasing after bad.

Pensions–the stock market crash is bad news for an unlucky few.

"Pensions hit as stock markets crash"  is the usual tabloid headline and in the past it was never true. That was for three reasons. Firstly many of us had final salary "Defined Benefit" (DB) pension schemes which guaranteed our pension even if the asset levels of the funds fell because Equities had fallen in value - however dramatically. Second these DB schemes were invested in a variety of asset classes of which Equities were only one. Bonds, Gilts, Property etc. were not (directly anyway) affected when stock values fell. Third the law requires that when Assets in a scheme fell, and if they stayed below Liability projections for some time, then the "sponsor" of the Fund, usually the employer, must fund the shortfall with a cash injection. Despite the changes in the world of pensions all of the above remains true for all of us lucky enough to be in DB schemes - crucially that includes almost everyone working in the public sector where DB remains the norm. These are the "Haves".

So what about the "Have-nots"? Over the past twenty years or so most DB schemes have been closed to new entrants and even before that significant numbers of workers either had no pension or had only a "workplace savings" scheme of far lower real benefit than DB. These savings schemes were often dressed up by employers and the Financial Services sector as being “Pension” schemes (and called “Defined Contribution” (DC)  Pensions) but in fact they were not. True on retirement the employee was required to purchase an annuity with the accumulated savings – and an annuity is a pension (of sorts!) by another name. But what DB gives in terms of predictable and often inflation-protected income in retirement is largely absent in a DC scheme. And the changes to the law in the 2014 Budget – the so-called “Pension Freedoms” - mean that a saver, if he or she chooses to, can take the money and run. There is no obligation to convert the built up “cash pot” into future income by buying an annuity.

Although we use the term “cash pot” the savings in DC schemes only actually become cash when the assets in which the pot has been built up are sold. And this is where falling stock markets are potentially very hazardous. DC scheme assets favour equities because over time such an investment provides higher returns than more secure but lower return asset classes like bonds and gilts. The key point here is “over time” – indeed the timeframe is absolutely crucial to DB schemes where short term falls in stock values are largely irrelevant because the timeframe over which the assets have to deliver returns is so long – thirty years or more. And over the decades, despite swings and roundabouts along the way, the stock market will provide a better outcome than the alternatives.However there is one exceptional risk for DC schemes which does not exist for DB. The value of a saver’s pot  depends on the value of its underlying investment on the day that the employee becomes a pensioner. And that day is usually predetermined. So if the Stock Market has fallen 10%  a few days earlier the employee’s pot will also have fallen - and the amount of his pension (if he buys an annuity) similarly.

The switch from DB to DC has taken the risk associated with pensions away from the employer and placed it on the employee. It has removed the guarantees inherent in a DB scheme  - there is no expectation that a DC scheme  will deliver a pension that relates in any way to the employee’s recent earnings. Nor that it will be inflation-proofed. Nor even that the actual value of a pension pot will not be subject to the vicissitudes of stock markets.

There have been some positive developments in pensions in recent times – not least “auto-enrolment” which brings many employees into workplace savings (for retirement) who were not there before. But the switch from DB to DC has been a social shift of a scale which has still not been fully understood. In the public sector, post Hutton, benefits have been somewhat reduced but an employee – including new employees – still has a DB scheme of which to be a member and benefits from it which far exceed the new DC norm in the private sector.  Not least of these is the fact that the “shock horror”  headlines really do not apply to DB schemes members at all. They may not apply to all DC schemes members either – but for those approaching retirement and the moment when they cash in their “Pot” it really can be very bad news indeed. 

Michelle Cracknell – building TPAS into the UK’s main resource for Pensions guidance for employees and pensioners.

 

“We are” says Michelle Cracknell, the Chief Executive of The Pensions Advisory Service (TPAS), “for the first time in my lifetime, reaching a consistent approach to pensions in Britain”. Cracknell has been in her job a little under a year but she is clearly enthusiastic both about her role at present and especially about the possible opportunity for TPAS to deliver the guidance announced in March 2014 Budget. She also relishes the public service aspect of the job, which provides her and her staff with high levels of job satisfaction.

 

Early Days

Michelle Cracknell was born into a Royal Air Force family and like many Armed Forces children she was sent to Boarding School – Christ’s Hospital in her case a school where pupils’ fees are assessed according to family income which, she says, results in a social and cultural diversity that is unusual and very special. Cracknell thinks that this background not only set some important values in place but also gave her a “dogged determination” to succeed. After school, she went to Imperial College where she studied Civil Engineering but instead of pursuing an engineering career she decided to go into the Financial Services sector. She joined the independent advisory consultancy “Advisory and Brokerage Services Ltd (A&B)” which specialised in the high net worth private client sector - as well as having a substantial corporate client portfolio. Cracknell’s pensions involvement was both with individuals’ personal pensions and also with small corporate schemes. She recalls the first rumblings of corporate concern about the cost and obligations of Defined Benefit pension schemes surfacing at the time around 1990 when Government signalled an intention to require DB schemes to index-link pensions in payment. Many small schemes were closed by sponsors in response to this “threat” (a threat which became a reality in 1997).

 

Working for a “Provider”

When A&B was acquired by AEGON in 2002 Cracknell stayed and became part of this much larger company for whom she worked for five years. Then, in 2007, she moved away from pensions, temporarily as it turned out, when she joined Skandia (part of Old Mutual Wealth) as Director of Strategy – just in time for the Global Financial Crisis! It was Cracknell’s first experience of working for a “provider” and in challenging times. She readily accepted that she was not an expert in investment but says that “…you didn’t really need to be an investment expert to work on the company’s strategy”. She had responsibility for the company’s strategy for the post Retail Distribution Review landscape , which included the disposal of the non-core business Bankhall to Sesame as well as other restructuring projects.

 

Pensions Consulting

In 2010 Cracknell decided to leave Skandia and become a management consultant with Bluerock. She says that the ongoing trend towards the closure of DB schemes, the planned introduction of Auto-enrolment, the Government’s “Retail Distribution Review” affected firms across the value chain and presented opportunities for her to consult and advise. I asked whether she detected a declining enthusiasm on the part of employers to make pension arrangements for their staff. She said that there was some of this but that this was countered by the realisation that with age discrimination legislation coming into force unless employees felt confident about their personal financial circumstances on retirement they may well stay in their jobs – which was very often not the ideal outcome for the business!

 

The attractions of TPAS

In 2013 Cracknell was informally approached about the position of Chief Executive of TPAS. Initially unsure she took soundings and did research on an organisation about which, she admits, she previously knew little! The more she learned about TPAS the more she came to the view that it could offer her a big opportunity to work in an area where she could genuinely be a force for good. Above all, the independence of TPAS was the key and its mandate to serve the public, directly and professionally. Cracknell was not a “shoe-in” for the job which she had by now decided she really did want! Competitive interviews were held and there was a month of nail biting before she was advised that she had been appointed!

 

A Stimulating Work Environment

If altruism was the driver for Cracknell to become the boss of TPAS, the stimulating work environment was soon to confirm to her that she had made a good choice. There are twenty skilled people on the “Helpline” answering queries and helping callers on a wide diversity of pensions related matters. There is a huge volunteer back up with no fewer than 370 volunteers across the country (two thirds of whom are still in fulltime work as lawyers, actuaries etc.) TPAS is not a consumer body and has no conflicts of interest. So when there is a pensions dispute to be resolved (one of their key roles) they can and do offer genuinely independent advice. With a budget of around £3.8 million TPAS is a modest charge on the general Pensions Scheme levy. Following the 2014 Budget, the Service’s role may well expand.

 

Surviving the “War on Quangos”

For TPAS to be credible as a service at a time when there has been a “war on Quangos” they must not only offer timely and professional advice but do so in a cost effective and sympathetic way. With 80,000 cases dealt with last year (that’s about £40 a case) there is certainly value for money. And with all the front line staff trained in counselling skills (with help from The Samaritans) there is plenty of sensitivity as well. Immediately following the Chancellor’s recent Budget, the number of cases being handled every day by TPAS tripled – and this is almost certainly the precursor of a greatly expanded role for TPAS. In the Budget, the Chancellor announced that there would be “Guidance” provided to those retiring with Defined Contribution pots now that an Annuity purchase is not mandatory. The Treasury Select Committee followed this by saying that this guidance must be “demonstrably impartial” – which may preclude Financial Service providers from providing the guidance. This is a huge opportunity for TPAS who, along with the Money Advice Service (MAS) and the Citizens Advice Bureau, are in the prime position to be the approved providers of advice.

 

Expanding TPAS to provide Guidance for all

Michael Cracknell is enthusiastic about the joined-up approach to Pensions which has emerged in recent times – single tier State pension and private pension reform - and she sees Guidance as being a crucial addition to this coherent approach. She is confident that TPAS is the right body to provide a guidance service who TPAS will need at least to double its resources to meet the demand. Cracknell says “Savers must know all the options that could be right for them - and every case is subtly different. TPAS has the experience and the skill set to do this and its independence is well established.” The workplace savings waters are choppy at times and there are sharks around (the scams of “Pensions Liberation” are something that TPAS frequently warns callers about). One Pensions commentator called TPAS “Britain’s best kept financial secret” and that is something that Michelle Cracknell seeks to change. She wants TPAS to be better promoted and better known – the more guidance they are called upon to give, the better. It looks likely that with the Government’s commitment to Guidance this is sure to happen.

Paddy Briggs

This article first appeared in the July/August edition of “Pensions Age”

23^rd June 2014

Union action may be counter-productive – especially over Public Sector pensions

 

The Tories, unsurprisingly, are using the upcoming Public Sector one day strike as a reason for a bit of Union bashing.

As a Director of a large private sector Pension Fund for four years and as a writer and commentator on Pensions matters I have thought a bit about the subject of the disparity in benefits between the two sectors. It isn't just pay (as Tim Montgomerie points out in the article in “The Times”) that favours the Public Sector, it's pensions as well. Most public sector employees are in Defined Benefit (DB) schemes which are still open to new recruits. In the Private Sector most of these schemes are closed to new entrants who are offered only the far inferior Defined Contribution (DC) scheme instead. (With the Budget changes the reality that such schemes are not proper Pension schemes anyway but workplace savings devoid of proper Pension guarantees was made crystal clear).

In future private sector employees, except for the fatter cats at the top, can expect to work longer and enjoy much lower retirement benefits than their opposite numbers in the public sector. This may skew some in the employment pool towards the public sector rather than the private  - if the jobs are there. As most public sector schemes are unfunded this will continue to be a large part of Government spending. It is true that post Hutton public sector employees retirement benefit prospects are somewhat lower. But they are still far, far more generous than the private sector will offer.

We are, in the private sector, largely in a post Union world. Workers’ rights, including pay and pensions, have slipped so that there is less job security, lower (comparatively) pay, hugely reduced retirement benefits, longer working lives etc. The destruction of collective bargaining means that there are few if any, fora for negotiation and debate. Nobody protects workers interests any more. In the public sector this is not the case.

Tim Montgomerie and many others on the Right want the public sector to be more like the private sector - code for reducing Union power and allowing lower pay and lower benefits to be forced on the workforces. Although I do not believe that the Unions should be striking at this time - especially over pensions - I welcome their continued presence in the public sector world and greatly lament their disappearance from the private sector. It's back to the future when Victorian employment practices become the norm and there is nobody to stand up for the workers any more.

Its a Pensions revolution in prospect

I doubt that any forecasters looking at what the 2014 Budget might have in store for us predicted the demise of “Defined Contribution (DC)” Pensions Schemes as we know them. But that is in effect what the Chancellor of the Exchequer announced yesterday. It will take a bit of time to get used to the new world and as the Chancellor hinted it might not just be DC scheme members who “benefit”:

“There will be consequential implications for defined benefit pensions upon which we will consult and proceed cautiously”

Let’s look at what this might mean in a moment. But first what about the saving for retirement revolution that will soon get underway – for that is what it is? I have always thought that to call a DC plan a “Pension Scheme” was a misnomer – the fiction was convenient to some, not least employers, who could claim that they were finessing their Pension offer by moving from Defined Benefit (DB) to Defined Contribution. In fact, of course, DC has never been a Pension Scheme at all but a savings scheme. The only thing that made it comparable with DB was that on retirement the member had to buy an Annuity with the pot of the scheme (or 75% of it anyway). In other words by contributing to a DC scheme you were buying yourself a Pension so in that sense it was indeed a Pension scheme. With one fell swoop the Chancellor has changed that. DC is now a savings scheme pure and simple. Of course as the Chancellor said:

“Those who still want the certainty of an annuity, as many will, will be able to shop around for the best deal.”

…but they don’t have to. If they want to take their pot as cash and spend it on a round the world cruise or two they can. In effect Osborne is throwing down a challenge to the Financial Services sector to invent products that might be so good that retirees won’t want to blow their pots in one go! And those products have to be a darn sight better than the current Annuity based deals don't they? An average DC pot of £25,000 gives you an annual annuity-based income of around £1400 at 65. You'd surely “take the money” if that was the best you could get wouldn't you?

So what about DB schemes and was the Chancellor really hinting that he might apply the same principle to these? Well the ideological driver must be the same. This is what he said about that:

“People who have worked hard and saved hard all their lives, and done the right thing, should be trusted with their own finances”

So if this is you and you happen to be in a DB scheme what is the value of your “pot” if you retire at 65 and will receive a Pension of say £15,000 (the average pension in many major private sector UK schemes). Well based on current Annuity rates that value is around £300,000. So if we apply the  new DC rules to this the retiree could walk away with a sum not unadjacent to this to do with what he will. Attractive for many I would think. If this happened the Liabilities of the DB scheme would reduce coincidentally with the retiree deciding he will have jam today rather than Jam tomorrow. If the majority of retirees took the cash option then there would be major implications for DB schemes of course. Assets would reduce annually by the total amount of pots cashed in, but Liabilities would reduce as well. It will need an actuary to work it out (as always!) but I would guess that the funding ratio would be unaffected, though the fund’s cash flow would be heavily negative of course. In the extreme variant of this you could even offer those of us actually drawing pensions the chance to convert our remaining future Pension entitlement to cash at any time. Sponsors with healthy mature schemes might actually like this a lot – it's the ultimate de-risking!

So given the Chancellor’s declared predilection for “trusting people with their own finances” why didn't he do this? My guess is that the public sector pensions burden makes it impossible – at least for the foreseeable future. Public sector schemes are DB - but most of them differ from private sector schemes because they are unfunded. So there are no Assets out of which to pay the cash pots – the money would have to come from the Treasury! And given the continuing size of the budget deficit no sane Chancellor would want to increase public expenditure if he didn't have to.

So there we are. A Pensions revolution no less with maybe more to come. A challenge ahead for everyone in the Pensions world. Interesting times!

Proper Pension provision a casualty of an illiberal age

It gets insufficient media attention but to me one of the worst developments of the illiberal imperative Will Hutton writes about here in the Guardian is in regard to Pensions. As recently as ten to fifteen years ago final salary pensions were the norm in both the Public and the Private sector. Now the value of Public sector pensions has been eroded and decent Private sector pensions have vanished. Defined Benefit pension schemes offered comfort in retirement. Their replacement the Defined Contribution schemes are pathetic substitutes that offer little - certainly not enough to live on unless you are a very high earner. This switch did not happen because of Government action but because of inaction. Labour did not have it in its 1997 election manifesto. But they presided over this fundamental change to citizen rights (especially from 2003 to 2010) and must be roundly criticised for allowing it to happen. The companies couldn't believe their luck in being able to stop providing proper workplace pensions to their staff ! 

Let’s find a real Pensions cause for Boris to defend

by

Paddy Briggs

(From “Pensions Age” Magazine October 2012)

Boris Johnson, the Mayor of London, likes to see himself as a white knight leaping, as he puts it, “… to the defence of unfashionable causes” and in a recent article in The Daily Telegraph the cause he espouses is that of the Energy multinational BP. The corporation has apparently been threatened by a federal court in the United States with, in Boris’s words, “…and absolute crippler of a fine [which] some people say …will be in the region of $40bn”. Whether this is remotely likely I have no idea – it would be a sum that is nearly a third of BP’s market capitalisation of $135bn and would bring the very future of the company, at least in its current form, into doubt. Boris Johnson worries about this – and he is right to do so not least (in my view) because of the potential consequences for the members of the various BP Pensions Funds. But where I take issue with the Mayor is his statement that he needs “to speak up for everyone whose pension depends on BP shares” because “A lot of our pension funds have traditionally invested in BP shares, and if BP shares go down then that is bad news for UK pensioners…”

If a company the size of BP gets into serious trouble it is not good news for anybody but Boris is being alarmist and quite wrong to be so specific about the effect on UK pensioners. I am told that at the time of the Deepwater Horizon disaster in March 2010, when the company’s market cap. was around $180bn some $30bn of this was held by UK pension funds. In aggregate this is a huge sum and, in aggregate, if the unit share price falls this total value falls substantially as well - this is probably what Boris was referring to. But the reality is that it is doubtful if any single UK pension fund suffered materially as a result of this share price fall nor that any Fund would suffer if such a fall, or worse, happened again. A prudent investment policy, which all UK Pension Funds are statutorily required to follow, would preclude any fund having more than a fairly small percentage of its investments in any one Equity. In the case of the Fund of which I am a Trustee, for example, no single Equity represented more than 0.4% of our total investment at the end of 2011 ( although in theory we could have a higher percentage in one Equity if we chose to do so). It is also the case that a significant proportion of the Equity investments for many Funds is in vehicles which track indices like the FTSE and that if BP, or any other member of the FTSE, suffers a fall that is greater than the FTSE as a whole then the Fund’s holding in BP would decline anyway. There is a sort of self-correcting mechanism here which automatically favours investments in the more successful equities.

So if no individual pension fund has suffered significantly in the past, or will suffer in the future, from the collapse of the share price of one Equity like BP this, of course, means that contrary to what Boris Johnson is saying it is not “Bad news for UK pensioners” at all. As I mentioned, the real potential casualties from BP’s difficulties are BP pensioners and I am sure that the Trustees of the BP funds will be paying close attention to their sponsor’s covenant in these difficult times. But the BP fund is in the Top 10 of UK Defined Benefit scheme in respect of Assets Under Management and has, given the difficult economic times, a satisfactory funding ratio. I am sure that the BP Fund Trustees are not being complacent but it seems to me that it would only be in the case of a successful predatory takeover of BP that the status of the Pension Fund would be brought into question. And if that had been going to happen surely it would have been in the first half of 2010 when the value of the company halved in a few weeks following Deepwater Horizon?

To return to the Mayor of London and his defence of unfashionable causes. The cause that I would like to see him and other politicians pick up is that of our private sector retirees of twenty, thirty and forty years’ time. Public sector employees have, whatever they might think or say, been offered a Pensions deal which though not as good as in the past will still, in the main, give them a secure retirement. All too many private sector employees, however, have been offered no deal at all. If ever there was a ticking time bomb – and genuinely “bad news” for (future) UK pensioners - it is this. This is a real cause to “unsheath your columnar Excalibur” for Boris!

Paddy Briggs is a Member Nominated Trustee of the Shell Contributory Pension Fund. He writes in a personal capacity.

Paddy Briggs