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Pensions Watch - issue 26

Swap shop

In a UK first, two of, industrial goods and services group, Babcock International’s defined benefit (DB) pension schemes are poised to enter into a longevity swap to guard against the risk of the scheme’s current pensioners living longer than expected.  In Babcock’s case, the swap will provide protection for a maximum of 50 years.  A longevity swap, unlike a buyout or buy-in, doesn’t require the scheme to transfer its assets and liabilities or make an upfront payment to a buyout firm.  Instead, rather like an inflation swap, the scheme exchanges a series of regular fixed payments for a series of regular variable payments with the increasing number of investment banks and insurance companies that are now willing to act as counterparty in this nascent market.  For a longevity swap, however, the variable payments received by the scheme relate to the actual lifespan of the scheme’s pensioners whilst the fixed payments made reflect their expected lifespan.  Longevity swaps can either be index-based, based on population-wide longevity, or bespoke, as in Babcock’s case, where sufficient mortality data on the scheme membership exists.     

Prof David Blake, Director of the Pensions Institute at the Cass Business, who has for several years advocated the need for a liquid and transparent market in longevity risk, has recently called for the UK government to issue longevity bonds linked to the future survival rate of specific cohorts of the population, eg males aged 65 in 2010, alongside conventional and index linked gilts.  In so doing, a more liquid and transparent longevity derivatives market might develop, in the same way that the interest rate and inflation swaps markets, based on the conventional and index linked gilts market, have grown exponentially over the past 15 years.  Crucially, a more liquid market in longevity risk might enable DB pension schemes to mitigate this particular source of unrewarded risk and more reliably meet their liabilities.    

Meanwhile, the Pension Protection Fund (PPF), the UK DB occupational scheme safety net funded by occupational schemes, has appointed Hewitt Associates to advise it on the cost and methods of mitigating the longevity risk it faces.  

Please hold the line

As the trustees of the £29.3bn BT pension scheme seek to conclude the triennial funding valuation of the UK’s largest DB scheme, BT, which slashed its dividend to shareholders by 59%, has agreed to nearly double its annual contributions of £280m to the pension scheme over the next three years to £525m.  It is obliged to do this under a “true up, true down” agreement struck between the company of the trustees in 2005, where the scheme’s investment returns, which are still heavily dependent on the fortunes of the equity market, can markedly impact the company’s contribution rate.  Indeed, a failure to generate a real (inflation adjusted) annual return of 3.2%, obliges the company to raise its annual contribution “in cash or in specie” to £560m.  Despite the 88% hike in the annual contribution, The Pensions Regulator is refusing to allow the scheme’s deficit recovery plan to extend beyond 10 years until the deficit has been calculated using sufficiently prudent assumptions.  Apart from the scheme’s IAS19 deficit of £2.4bn being derived from, arguably, over inflated corporate bond yields, the scheme also adopts what are generally considered to be outdated longevity assumptions.  (They trail those of its competitor Cable & Wireless by up to 5 years).  Indeed, some pension pundits believe that if the scheme’s liabilities (which are more than double the company’s stock market capitalisation) are valued on a more conservative basis than that of IAS19 and more realistic longevity assumptions are factored in, the deficit could double or even treble.      

Opportunity knocks

According to the Office for National Statistics, institutional investors, comprising pension funds and insurance companies, sold a net £17bn investments in the fourth quarter of 2008; the fastest rate of disinvestment since 1987.  In addition, the latest Mercer Asset Allocation Survey suggests that only 2% of UK DB schemes will increase their domestic equity weightings over the next year, whilst a third will cut their UK equity and a fifth their overseas equity holdings.  However, with ever larger deficits to plug, many private sector DB and local authority pension schemes are setting aside a small percentage of their scheme assets as “opportunities pots”, to target tactical investment opportunities, whilst simultaneously improving their investment governance by setting up investment committees to change and monitor their investment policies more effectively.  These opportunities include but are not restricted to becoming buy-to-let landlords and acting as bankers by lending to companies.  The Mercer study further confirms this trend towards more adventurous investment policies by reporting that 13% of schemes expect to move into or increase their exposure to alternatives during 2009.

Longer recovery plans

Whilst not publicly endorsing longer than 10 year timescales for DB scheme recovery plans, some consultants report that many schemes are gaining the tacit approval of The Pensions Regulator in moving to 15 year recovery plans – some as far out as 40 years.  Indeed, some believe 15 years may become the norm.

Every little helps

Against the backdrop of the Tesco DB scheme deficit widening from £600m to £1.1bn, Tesco has given its DB pension scheme contingent rights over £500m of its property assets. 

Fujitsu closes DB scheme

Following in the footsteps of Rentokil Initial, W H Smiths and Debenhams, Fujitsu, the Japanese technology giant, has closed its UK DB scheme, currently open to 4,000 members, to future accruals.  Whilst more than 70% of DB schemes are now closed to new members, closing schemes to future accruals remains relatively rare.  That said, Alliance Boots is considering following suit for its 16,000 member DB scheme.

Meanwhile…

Never knowingly undersold

The John Lewis Partnership Pension Scheme saw an influx of 11,000 new members to its non-contributory defined benefit (DB) pension scheme as it reduced the qualifying time for entry from 5 to 3 years.

And finally…

MPs fall short

Was it luck or judgement that £150,000 was chosen as the level at which the size of pension contributions and the tax relief thereon is restricted?  Despite the expenses bonanza, most MPs remuneration falls below £150,000.

 

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