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

The retreat from offering new employees a defined benefit pension in the private sector is now almost complete

 

The headline in the Financial Times was quite unequivocal: ‘Shell ends an era with pensions retreat’ and as a trustee of the Shell Contributory Pension Fund this and other similar press reports generated a fair amount of traffic towards me. This came from pensioners who wanted to know how they were affected and, especially, from many in the pensions world who wanted to know how I felt about it. It was in answering a question from one pensioner friend that I realised the full extent of the misconceptions that exist about the role of the trustee. Many fund members, and quite a few others, do not realise that a trustee’s duty is only to represent the interests of the existing members of the fund and that we therefore have no role in respect of Shell’s remuneration and benefits policies for its new employees. I was able to reassure those fund members that contacted me that Shell’s proposed closure of their main UK DB schemes to new entrants (subject to the consultation process that is currently underway) does indeed not impact at all on the existing members of the fund. I was also able to reassure colleagues and friends that, in my opinion, Shell’s sponsor commitment to these DB schemes is unwavering.

Shell’s expected decision is illustrative of the changes that have taken place in the world of workplace pensions in recent times. The origin of defined benefit pension schemes in the UK in the post-war years was a key part of the offer made to attract employees but also a feature of the more paternalistic culture of the times. In recent years, however, the private sector schemes have suffered what the Association of Consulting Actuaries (ACA) has called a “seismic collapse”. At some point over the past 10 years or so the norm switched from one under which the promise of a final salary pension on recruitment was standard to one under which only a defined contribution pension was offered. And once that switch had happened there was no turning back.

In its announcement Shell said that it reviews retirement benefits “to ensure that they are competitive in the local market and meet business needs” and that the DC scheme it will offer in future will offer “a strongly competitive retirement benefit so that Shell can continue to attract and retain the talent we need”. I have no doubt that this will be the case. But the key point from an employee perspective is that in normal circumstances DC schemes can never match DB schemes in what they deliver unless the levels of contribution made are at improbably high levels. True, the more you put in the more you get out but for all but the very highest paid employees it is unrealistic to expect that a DC scheme will deliver the same retirement benefits as a DB scheme. In the far from atypical Shell case most new employees joining in 2013 and retiring in say 2048 are unlikely to enjoy anything like the pension in retirement that the employee who joined in 1978 and retires in 2013 will benefit from. Next year’s retiree will get 1/54th of his final salary for each year of service - this was the accrual rate when he joined. So if he had a salary at the national average of £26,000 on retirement his 35 years’ service will deliver him a pension of around £16,000 – roughly 65 per cent of his final earnings. To achieve a similar pension from a DC scheme that employee would have to have built up a pot of around £400,000 at current annuity rates. In 2011 money, and assuming that the employee had worked for 35 years at £26,000 per annum, he would have earned a total of £910,000 over his employment years. That means that to have enough money in his pot he would have needed to build up an amount equivalent to around 45 per cent of his aggregate pre-tax income - every year he and his employer would have had to make contributions of £11,500 per annum to fund a pot sufficiently large to allow him to retire on a pension of 65 per cent of his final salary! The ACA estimates that at present average employer contributions to DC schemes are around six per cent with employees contributing on average four per cent - a total of 10 per cent compared with the 45 per cent necessary to equal the DB benefit. You can do the maths.

The background to Shell’s decision is not, as it may have been for some other employers who have done the same, because of any current problems with its UK pension fund. Indeed only four and a half years ago Shell halted payments into the fund and took a contributions holiday because it was so heavily in surplus at that time. (This, incidentally, gives a lie to the myth that the abolition of advance corporation tax relief, which removed tax relief on share dividends, and was introduced in the first Labour Government budget of 1997, was fatally damaging to the pensions industry as a whole. Well-managed schemes, such as the Shell fund, weathered that storm pretty well.) And presently, despite the turmoil in financial markets which has affected assets adversely and the falling bond yields that have increased liabilities, the Shell’s UK fund has a technical provisions funding ratio roughly in balance. If it chose to, Shell could probably afford to continue to offer a DB scheme to new entrants but the reality is that Shell judges that this is no longer necessary. What they have done is no more than virtually every other major UK employer has done as the FT and other media fairly pointed out.

Will Shell, and all the other private sector employers who have closed their DB schemes, come to regret it? in one area I think that they may. Obviously not offering a DB scheme to new entrants means that contributions, which are currently for Shell’s UK fund at a historic high of 31 per cent of salary (the contributions holiday is long gone) this to service the accrual of existing employee members will not have to be made for these new employees. The employer contributions made to the new DC scheme are likely to be much lower. However, when the current impasse over public sector pensions is finally resolved it is certain that the public sector will continue to offer generous retirement benefits - albeit somewhat less generous than is currently the case. A DB pension in the public sector based on career average salary will surely turn out over time to be beneficial compared with any employer’s DC offer. If you had a child or a grandchild considering career options and you compared for them the certainty of a public sector pension with the lottery of a DC pension I suspect that quite a few might turn their backs on the private sector and opt for the comparatively pension rich civil service instead.

We find ourselves in a world of unparalleled uncertainty – a world in which all too many of the old assumptions no longer apply. We cannot guarantee growth or employment or probably anything like the welfare benefits that we have enjoyed for more than 60 years – and as our economic systems struggle to adapt to the new realities, as individuals we struggle as well. One thing is, however, abundantly clear. The old paradigm of cradle to grave care, be it from the state or (partly) from an employer, is disappearing. An unintended consequence of these changes and of the growing disparity in retirement benefits between the private and public sector may mean that the pension cost advantages of privatisation as opposed to public sector provision could tip the case over in the direction of private enterprise. In the past companies ‘contracted out’ to save money and hassle so that they could concentrate their efforts on the added value rather than the cost side of the P&L. To offload any concern for future pensions liability from an internal DB scheme into a third-party provided DC scheme can be seen as more of the same. Whether there is intent on the part of government to encourage transfer of activities and personnel from the public to the private sector I don’t know. But there may be a paradoxical side-effect of making public sector pension benefits more attractive than those in the private sector. That is that some current public activities may become privatised simply because the long-term employment costs are lower in the private sector because of its lower pension cost loading!

Paddy Briggs is a Member Nominated Trustee Director of the Shell Contributory Pension Fund. He writes in a personal capacity and the views he expresses are his own

The Government’s raid on the Royal Mail Pension Fund

I am surprised that the Pensions world has so far been so sanguine about the extraordinary and unprecedented proposal by Government to sequester the Assets of the Royal Mail Pension Fund. The action is almost Maxwellian in its audacity and whilst presented as being in the interests of the members of the Fund it is in fact a cynical move designed to boost the Treasury coffers and prepare the Royal Mail for privatisation. Whilst the Fund has a negative Funding ratio it nevertheless has £28bn of Assets that employees, the sponsor and trustees have built up over the years. It is the members’ money and only they have a right to it.

By transferring members from a funded trust into the much less assured world of being an unfunded liability on the public finances is far from necessarily in their interests. As we have seen Governments can and do change the basis of Public Sector pensions at their discretion and there is little that anyone can do to stop them. A Pensions Trust provides legal protection to its members and has Trustees to exercise that protective role. At a stroke Royal Main fund members will lose that security and no longer have Trustees acting in their interests.

The Trustee and the Investment Adviser

 

Every Investment adviser, whether it be to individuals, Pensions Funds or other institutions, preaches the mantra that diversification is a good thing - don’t put all your investment eggs in one basket. The cynic might say that by arguing for spreading the risk the adviser is covering himself – especially if there is a counterbalancing component to the asset classes he recommends! As a Trustee I am expected to exercise due diligence in my legal responsibility of overseeing the appropriate investment of the Fund’s assets. This includes ensuring that there is an appropriate spread of risk so that the Fund is as protected, as much as possible, from the vicissitudes of today’s pyretic world.

However unlike most other investments where bigger is always better a Defined Benefit Pension Fund has no underlying imperative to grow - and its legal construct is also very different from that of a PLC or a Limited Company. For me and I suspect many other Trustees with a past or present business career an early lesson that needs to be learned is that we are not actually running a business at all. True there are superficial similarities to, say, the operation of a company offering investment products to consumers. But the core objective of a Pension Fund is different, which brings us back to diversification.

As an individual or a corporate investor I probably want to grow my assets and at the same time protect them. “How much risk do you want to take” is the often asked but always unanswerable question that advisers love to pose. It is unanswerable because risk is an abstract concept - until after the event that is! If the advice leads to my becoming much richer then, with hindsight of course, it was good advice – even if along the way the risks were large. If the advice leads to the diminution of my net worth then it was bad advice, even though the recommended portfolio was seemingly wise, diversified and comparatively risk free.

In normal times (remember them?) we minimise risk by being diversified and for a Pension Fund that usually means achieving a suitable balance between Liability hedging and Return-seeking assets. But what is a suitable balance – conventionally that is determined largely by the Funding ratio.

If a schemes Funding Ratio is strongly positive – say in excess of 125% - today’s imperative for many funds is likely to be to “derisk” – that is to say to switch substantially, possible even completely, from return seeking Assets into those that hedge against future Liabilities. In a way this is a bit counter-intuitive. If your Asset management policy has successfully got you into a healthy position then why not do more of the same?

The answer, of course, comes from the fact that a Pension Fund’s objective is not to make as much money as possible but to make sufficient to meet its liabilities – with some margin for error. It is arguable that mature funds which are closed to new entrants should do this as soon as they can. The fact that the Fund is closed means that no provision for new employees needs to be taken account of in the Liability calculation – this estimate can be predicated completely on the present and future demands placed on it by existing members.

But what if a Fund’s Funding Ratio is negative and the sponsor cannot or will not make up the shortfall sufficiently to allow a switch to Liability hedging investments? Here the conventional wisdom is that far more of the Fund’s assets should be placed in return seeking assets like Equities. For me there is a feel of the Roulette table about this! Presumably the main reason that a fund has got in trouble is because it has been too heavily committed to highly volatile stocks and shares rather than largely risk free Bonds and Gilts.

Is more of the same the correct medicine in these circumstances on the grounds that it must all come right eventually? I’m not so sure that it is.

One option might be to try and come up with an income generating investment portfolio which gives sufficient inward cash flows to cover annual pension payment obligations and not worry over much in the short and medium term about the value growth performance of the asset itself. Better a stable blue chip with good dividends than one that might (or might not) grow ahead of the market. It would be these challenges I would be throwing at my investment advisers at the moment.

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

Paddy Briggs

“Pensions Age” January 2012