From Ros Altmann:economist and pensions,
    investment and retirement policy expert

  • pensionsandsavings.com

    New scheme funding rules risk undermining Defined Benefit pensions and would cost employers billions of pounds

    New scheme funding rules risk undermining Defined Benefit pensions and would cost employers billions of pounds

    • Changes to pension funding rules pose a serious threat to workers’ future pension prospects. 
    • Measures supposedly designed to improve pension funding and security may well have the opposite effect.   
    • As exceptional monetary measures have damaged pension funding, pension schemes need more potential for asset growth, not less.
    •  The Pensions Regulator’s proposed new rules may require schemes to sell growth assets, forcing employers to put scarce corporate resource into the pension fund rather than the business.
    •  Government should encourage pension schemes to invest in infrastructure, social housing and growth projects, rather than buying gilts or other bonds.

    A row has been brewing about the proposed new funding rules for DB schemes, which the Government is supporting in the Pension Schemes Bill which has passed through the Lords and is now in the Commons.  

    Unfortunately, Ministers want to remove all the important amendments inserted by the Lords, including one which would help ensure many important Defined Benefit pension schemes can remain open, rather than having to close. 

    Measures supposedly designed to ‘reduce risk’ but may increase the risk of pension failure: The Regulator’s current proposals, which aim to ‘reduce risk’ uses a rather one-dimensional measure of risk. Aiming to reduce the volatility of investment returns, so that pension funds are less likely to suffer large losses during market downturns, also reduces the asset returns. Using standard risk models, which assume bonds match pension liabilities, and schemes need to have more ‘stable’ returns relative to liabilities, entails switching more assets into supposedly less volatile gilts or bonds. However, as this strategy also reduces the expected future returns which trustees would anticipate earning, then employers or members must pay more into the scheme. If scheme assets cannot be expected to increase as much as previously forecast, then employer or member contributions must increase to make up the difference with much larger contributions. LCP estimates this will cost employers sponsoring the top 100 schemes an extra £35-£40billion in the next ten years, relative to the current situation. Such huge sums may be far better spent on their business prospects, rather than long-term pension funding. 

    Prioritising pension funding over business growth in an economic crisis makes little sense: In the midst of a national economic crisis, forcing firms to increase pension funding sharply, instead of using their resources to boost their business, clearly increases the risk of employer failure. It is precisely this type of scenario which has benefited from the existing more flexible funding regime which the Regulator now wishes to replace. The existing rules allow much-needed leeway for a longer recovery period for scheme deficits, depending on the circumstances of each company. However, even with a suggested ‘bespoke’ route in the proposals, the overall thrust of the new regime would be to drive pension scheme trustees away from assets that could deliver really good returns in the long-term.  

    Monetary policy has damaged pension funding as QE drives long rates lower: The funding of DB pensions has been dramatically impacted by central bank policies which have artificially depressed long-term interest rates and thereby inflated pension liabilities. The lower the returns that scheme trustees can expect to earn in the long-run, the greater the amount of money that has to be contributed in the short-term. It is inevitable that, in an environment of ultra-low interest rates, the cost of pension funding will rise if the investments rely on fixed income assets. The interest rate environment aims to generate greater growth. This aim could be undermined by requiring businesses to boost pension funding, rather than investing in their own company’s long-term growth.

     Pension assets should be used for growth boosting projects: These long-term pension funds are ideally placed to invest in assets that can benefit the wider economy, as well as their own funding. This applies to all Defined Benefit pension schemes, which have hundreds of billions of pounds in assets, but most particularly to those schemes which are still open to new contributions. These schemes have a longer investment time horizon and are well placed to benefit from early stage investing in infrastructure, social housing, environmental and climate change mitigation measures and build to rent properties. The new pension funding rules would reduce the amounts available for investment from domestic pension funds into such important asset classes.

     Government should not remove Lords amendment to the Pension Schemes Bill: The House of Lords amendment to the Pension Schemes Bill would ensure that, at the very least, those Defined Benefit pension schemes which are still open, would not be forced into the so-called ‘risk reduction’ regime which also reduces potential returns significantly. This amendment was designed in consultation with trustees of open schemes, who have warned that they fear their schemes will become unaffordable if the new regulatory regime does not make particular allowance for their situation. The Government intends to remove this amendment from the Bill, but I believe it is vital that this remains in the legislation.

     Driving more pension schemes to close, rather than boosting growth, is bad for pensions and pensioners: If the Government does not ensure sponsors of open schemes are able to benefit from better expected long-term investment returns available from a diversified range of asset classes which may have higher volatility than fixed income but also higher returns, then these schemes will be forced to close, and members will be at risk of not receiving their pensions.

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