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Pensions Watch - March 2010
What goes up must come down
The aggregate deficit of those 7,800 UK private sector defined benefit (DB) pension schemes, covered by the industry funded Pension Protection Fund’s (PPF) safety net, improved from £51.9bn in January to £15.1bn in February. The improvement was as a result of the combination of a marked rise in gilt yields, which reduces the reported value of a scheme’s liabilities, and due to the bounce back in asset values, particularly in global equity markets. This time last year the deficit was £204.7bn. To put these numbers into context, the UK government’s budget deficit for 2009/10 is forecast to be £167bn.
False accounting
We noted in the December 2009 edition of Pensions Watch (please see “Bean counters push for risk-free rate”) that the International Accounting Standards Board (IASB) continues to push for the application of a risk-free discount rate to the valuation of DB scheme liabilities on sponsors balance sheets, rather than the current, more generous, AA-rated 15 year bond yield. However, it is now also seeking to abolish the inclusion of, what is in many cases, a somewhat overoptimistic expected rate of return from DB pension scheme assets within the sponsor’s profit and loss account. Currently, sponsors of those DB schemes which have a material weighting towards risky assets, such as equities, bolster their annual profits by posting an expected, rather than the actual, return for the risky assets that the scheme holds minus the actual increase in the balance sheet value of the scheme’s liabilities over the same period. The IASB is proposing that this expected rate of return in the profit and loss account mirrors the discount rate applied to the scheme’s liabilities in the balance sheet. So, for a fully funded scheme the two calculations would cancel each other out. Separately, the NAPF has called for the creation of accounting standards that better recognise that DB scheme liabilities are long term – that is a methodology that moves away from the annual marking-to-market of a scheme’s assets - whilst providing investors with greater transparency of a company’s pension obligations.
Unfunded public pensions
Whilst the travails of private sector DB schemes continue to be the main focus of attention for the pensions industry and the tabloid press, the National Audit Office (NAO) has stepped up its warnings over the parlous state of unfunded public sector pensions. In 2008/09, pensions in payment from the “big four” unfunded schemes – those for the NHS, civil service, teachers and the armed forces – rose 38% on 1998/9 to £19.3bn and, according to the Government Actuary’s Department (GAD), are set to triple to £79.1bn by 2059. However, underlying this number is the bold assumption that the headcount within the public sector won’t rise over the next 50 years despite the Treasury predicting 20% growth in the UK working population by 2059. This would mean public sector employment falling from its current 21% of the workforce to 16.3% in 2059. Separately, Towers Watson have calculated that unfunded public sector pension promises now total an eye watering £1.2tn (that’s £1,200bn), against the government’s official figure of £770bn as at 31 March 2008.
Feathering the wrong NESTs?
The Department of Work and Pensions (DWP) surprised a number of people by announcing the charging structure of the “low cost” NEST scheme, designed for those on low to moderate incomes from 2012. Although a 0.3% annual management charge (AMC) is to be levied throughout the lifetime of each investment, a 2% initial charge will be levied up front on contributions to meet the £600m government start up loan costs of the scheme. (Tata Consultancy Services has been appointed on a short term contract to administer the NEST scheme and looks set to earn £600m over 10 years if the deal is renewed in October once short political uncertainty has dissipated). Despite the NAPF suggesting that this up-front charge might discourage saving in the scheme, the Investment Management Association and the TUC described it as “a pretty reasonable compromise”. According to a separate report compiled by the DWP, trust-based defined contribution (DC) schemes have a median AMC of 1%, met by the employer in 77% of cases, and for contract-based DC schemes AMCs range from 0.15% to 1.5%. As to investment policy, rather than opt for capital guaranteed funds, in all likelihood NEST will opt for a series of - perhaps as many as 40 - target date funds. The asset mix of these funds would become more conservative as each approaches maturity. Interestingly, the Financial Times posed the question: “Is NEST the new poll tax?”
Pensions are best
The latest NAPF Workplace Pensions Survey makes interesting reading for all the right reasons. 44% of respondents placed pensions as the most importantmeans of saving, whilst just over a quarter said they would have more confidence in pensions if they could guarantee not to lose money while building up their pensions pots and for their pots not to dry up before they died. 77% of respondents said that they would view an employer offering an occupational pension scheme more positively than one that doesn’t, while 38% consider pensions the most important employment benefit aside from salary. In a separate survey, the NAPF found that 71% of employees valued financial security above health as the key to a happy retirement.
Unhedged risks pose threat to financial stability
According to consultant Hymans Robertson, the majority of FTSE 350 DB pension schemes are not a significant financial burden to their sponsoring companies. Indeed, excepting those five FTSE 350 companies that have DB scheme deficits that exceed their respective market capitalisations – British Airways, BT, GKN, Interserve and Trinity Mirror - half have a deficit below 6% of their marketcap. However, many are running significant unhedged investment risks that could potentially result in losses of up to 20% of their stock market values if equities and gilt yields were to fall simultaneously. Recent surveys conducted by Metlife and Clear Path Analysis each suggest that the appetite for de-risking continues unabated.
Longevity hedging
In last month’s Pensions Watch we reported that consultant Hymans Robertson expects £10bn of longevity hedging transactions to be executed in 2010. These transactions protect DB schemes against the risk of their pensioners living longer than anticipated. Indeed, according to a report that draws on the knowledge and experiences of pension scheme managers, trustees, consultants and academics, entitled “Longevity hedging for pension schemes” and compiled by Clear Path Analysis, longevity hedging stabilises DB scheme pension liabilities, frees up cash and ultimately improves a company’s share price. However, the report also highlights the importance to trustees of ensuring that these long term transactions can be unwound at a reasonable price or passed on as part of a buy-out if the end game is to take the scheme to buy-out.
No plane sailing for British Airways (part 2)
Following on from the “No plane sailing for British Airways” story in the November 2009 edition of Pensions Watch, and against the backdrop of an aggregate £3.7bn deficit and annual sponsor payments of £330m, British Airways have now reached agreement with the unions over preserving the accruals of future benefits for the active members of BA’s two DB schemes. Those active members seeking to retire at 60 will see their contributions rise from 8.5% to 13% of salary, so raising an additional £37m per annum for the scheme.
MPs pensions
According to independent pensions consultant John Ralfe, the official cost of financing MPs pensions is £17,000 per annum greater than the official cost to the taxpayer of £13,000 per MP.
And finally…
Pass the parcel
What do Alistair Darling, Andrew Smith, Alan Johnson, David Blunkett, John Hutton, Peter Hain, James Purnell and Yvette Cooper have in common? They’ve all held the post of Secretary of State for Work and Pensions since the post was introduced in June 2001. Only Andrew Smith has held the post for more than two years and in 2005 there were no fewer than three incumbents.
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