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Pensions Watch - May 2010

Public pensions

The forced marriage of the Tories and Liberal Democrats has started the wheels turning on some serious pension policies.  Principal amongst these is the promise to investigate the long-term affordability of public sector schemes via an Independent Commission.  The spiraling cost of unfunded public pensions, most recently estimated by Towers Watson at £993bn, has been a recurring theme within recent editions of Pensions Watch.  This investigation comes against the backdrop of a recent Bank for International Settlements (BIS) paper entitled The future of public debt: prospects and implications (please see: http://www.bis.org/publ/work300.pdf) that suggests that if current fiscal and public pensions policy is left unchecked, then in 2050 UK public debt could hit 500% of GDP.   To put this into context, Mr. Brown’s “Golden Rule” was to keep net debt at or below 40% of GDP over the business cycle.

A further pledge, that prompted Hargreaves Lansdown to write ‘pensions industry in shock as government announces sensible pension policies’, is to restore the earnings link for the basic state pension.  From April 2011 pensions will be raised by the higher of earnings, prices or 2.5%.  Indeed, the newly installed pensions minister Steve Webb is known to be a keen advocate of making state pension provision the primary source of retirement income and has, in the recent past, cast doubt over the value of auto-enrolling lower to middle income employees into the proposed National Employment Savings Trust (NEST).  (Interestingly, the Australian government, in an effort to boost Australia’s public pensions savings pool, has proposed a 40 percent “resource super profits tax” on all mining industry profits above the long term government bond yield). 

Less popular is a review of the date at which the state pension age starts to rise from 65 to 66.  Under changes brought in by the previous Labour administration, the state pension age was due to rise for both men and women to 66 between 2024 and 2026, then to 67 between 2034 and 2036, and to 68 between 2044 and 2046.  The state pension age for women was due to rise to 65 between 2010 and 2020.  However, with official projections of life expectancy having been revised dramatically since the current timetable was drawn up, the move to 66 could be implemented as soon as 2016 for men and 2020 for women with a state pension age of 70 for both by 2046.  Moreover, it has been suggested by some that the government should adopt a more radical approach by looking at the viability of varying the state pension age according to an individual’s life expectancy.

Separately, the Local Government Pension Scheme (LGPS) has suggested that the scheme should move to a Normal Retirement Age (NRA) of 66 in 2016 and consider a move from final salary to career average earnings, quite possibly applying both measures retrospectively to accrued benefits.  These suggested changes have been made in addition to proposals to increase contributions for high earners and making indexation optional for pensions in payment and accrued benefits.

Funding positions

The aggregate funding of those 7,400 UK private sector defined benefit (DB) pension schemes, covered by the industry funded Pension Protection Fund’s (PPF) safety net, recorded a £2.2bn deficit at the end of April, compared to a £0.3bn surplus in March - the first surplus since June 2008.  Meanwhile, Pensions Capital Strategies reported that the combined pension deficits of FTSE 100 DB schemes rose from £52bn in April 2009 to £73bn in April 2010, largely due to the dramatic rise in inflation expectations over the past year.  The firm also identified nine FTSE 100 companies whose heavily indebted DB schemes pose a material threat to their business models.   In each case, scheme liabilities exceed the sponsor’s market capitalisation.  

Increase in scheme deficits

The Royal Mail pension scheme has seen the value of its IAS19 deficit balloon from £3.4bn to an eye watering £8bn, despite having employer contributions of £867m over the past year.  Meanwhile, BT reported a £2.8bn increase in its IAS19 deficit to £5.7bn.  Despite these gargantuan numbers, in both cases the IAS19 position underplays the actuarial deficit.  (Please see the February 2010 (“Wrong number?”) and October 2009 (“Royal Mail to post increased pensions deficit”) editions of Pensions Watch).

Pension contributions on the wane

HM Revenue and Customs reported that employee contributions to occupational pension schemes fell from £6.3bn in 2007-08 to £5.3bn in 2008-09, while employer contributions rose from £7.4bn to £7.7bn.

Special Purpose Vehicles

Marks and Spencer, Sainsbury, ITV and Whitbread look to have started a trend amongst larger indebted DB schemes by placing the sponsor’s key assets, typically the sponsor’s property portfolio, into a Special Purpose Vehicle (SPV) as a means by which to improve pension scheme funding.  In so doing, the asset’s ownership is shared between the pension scheme and the sponsor and counts towards the deficit recovery plan.  The Marks and Spencer SPV that holds £300m of the company’s property portfolio is part of an £800m funding plan to meet its £1.3bn deficit and through a leaseback agreement additionally provides the 123,000 member pension scheme with an annual income of £36m for 15 years from 2017.  Sainsbury has utilised its £750m property portfolio which will similarly provide its scheme with an annual income, in this case £35m for 20 years.  Whitbread has put its £228m Premier Inn hotel chain property portfolio and rights to a proportion of the income generated from the chain over the next 15 years into a SPV, whilst ITV used a SPV to share ownership of a subsidiary company with its pension scheme.  A number of Local Authorities are rumoured to be considering putting prized public buildings into SPVs to alleviate their pension funding problems.

Schemes plan to de-risk

Having surveyed 243 trustees, consultants and pension fund managers, with aggregate assets under management of £50bn, the results of the Engaged Investor and Pension Corporation de-risking survey, entitled The Future of Pension Schemes, found that 73% of schemes plan to de-risk in the next few years though 65% cited cost as a barrier.  Indeed, with potential demand outstripping potential supply in the buy-out market for instance, buy-out costs have been gradually creeping up.  It additionally found that 57% of trustees are considering implementing a liability driven investment (LDI) strategy, 35% are looking at removing longevity risks while 45% believe either a buy-in or buyout is the way forward. 

This comes as many in the industry are predicting a record year for de-risking business - £15bn being the current consensus – double the amount of 2009, with possibly £10bn of this being in the form of longevity swap deals as the number of entrants to this nascent market starts to increase markedly.  (Please see “De-risking on the rise in the February 2010 edition of Pensions Watch). 

Separately, reports suggest that a number of smaller DB schemes are taking full advantage of the relatively advantageous pricing of longer dated gilts over interest rate swaps in implementing LDI strategies, despite the fact that gilt yields remain at near historical lows in absolute terms.  In addition, despite the, in some cases aggressive, move into gilts at the expense of direct exposure to the equity market, some schemes are using equity futures as a means by which to maintain an exposure to the equity market.  

And finally…

Talk like an Egyptian

The colourful Egyptian millionaire, Mohamed Al Fayed, tried unsuccessfully to pay himself a dividend from Harrods’profits, before making good the Harrods’ pensions scheme deficit.  His failed attempt to extract the cash, that he felt was his due, ultimately led to his decision to sell the landmark Knightbridge department store and a four letter tirade aimed squarely at the trustee board.   An extract of the rant reads as follows: “…it came just as a surprise that the Government put a body in called pension trustee….I can’t take my profit because I have to take a permission of those #!£*&#% idiots.”  You get the picture.

Addendum: New yardstick for DC default funds

We noted in last month’s Pensions Watch that the FTSE Group and PensionDCisions have launched fi ve indices designed to benchmark the performance of multi-asset defined contribution (DC) default funds. PensionDCisions have asked Pensions Watch to point out that while the indices are an objective refl ection of where DC plans stand today, i.e. the majority of large DC plans do not invest much beyond equities, bonds and cash, as soon as any additional asset classes reach a nominal threshold, the indices will incorporate them.

If there are any DC pension scheme trustees out there whose DC scheme has adopted a default fund which invests in alternative asset classes, please do let PensionDCisions know via their research link: http://www.pensiondcisions.com/research/index.php. In so doing, you will be contributing to the development of the asset classes reflected in their index series.

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