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From Our Perspective: Brexit adds to the pressure

Future observers might point to the 23 June EU referendum as a turning point for UK occupational pensions. The fall in Gilt yields since the Brexit vote as investors headed for safe-haven assets, has added pain to trustees and sponsors, vindicating those who had hedging strategies in place. The yield on 30-year paper dropped to around 1.26% in early August 2016, down from around 2.5% a year previously, following the Bank of England’s decision to decrease interest rates and its announcement of more QE.

In this issue, Craig Gillespie, an investment consultant at Aon Hewitt, points to the centrifugal forces that pull pension funds in two separate directions, which he describes as a “grand bargain”. On the one hand, QE is an attempt to push investors away from risk-free assets (and the government’s stated policy is to encourage investment in infrastructure). On the other, regulation highlights the importance of benefit security and tends to push investors towards low-risk investments. 

The result is a mess as low-risk investment strategies and low yields exacerbate deficits. Hymans Robertson calculated that the UK aggregate pension deficit hit £1trn (€1.16trn) at the beginning of August.  

One post-Brexit assumption is that inflation will trend upwards as the weakness of sterling plays through the economy. Rising yields, as a consequence of this, would allow deficits to fall. Yet those who think interest rates are at historic lows have been consistently wrong over many years.

“What gets measured gets managed,” the management specialist Peter Drucker, is believed to have said. In the case of UK occupational pensions, a continual flood of data on aggregate deficits has not necessarily led to better management of assets and liabilities, especially at the smaller end of the scale.

The failure of the UK retailer BHS has highlighted how difficult it is for the Pensions Regulator (TPR) to monitor individual funds as closely as its counterpart in the Netherlands does on an ongoing basis. Consolidation of funds (which TPR wants) would make this exercise easier but is difficult in practice.

A recent report by the Pensions Institute of Cass Business School in London (‘Milking and Dumping: The Devices Businesses Use to Exploit Surpluses and Shed Deficits’, Keith Wallace) notes TPR has “irreconcilable” legal objectives in its mandate to secure benefits while simultaneously protecting sponsor companies and their shareholders. 

On the face of it, the proposed increase in TPR’s powers to scrutinise merger and acquisition plans of sponsoring companies would be welcome but insufficient if the Pension Institute’s report is to be taken at face value.

Rather than a piecemeal reassessment of TPR’s powers, a better approach would be to have a wholesale rethink. Given the significance of occupational pension assets in the national retirement savings pool, and the size of deficits relative to the market capitalisation of sponsors, the regulator should be allowed to step up its game.

Taking Drucker’s adage into account, there is a case for improving micro-level assessment of pension funds and their sponsor’s balance sheets, which would require greater resources. The Pensions Regulator could become part of the Prudential Regulation Authority, under the auspices of the Bank of England. 

While this would be no guarantee of organisational success or per se ensure greater resources, it would solidify the organisation’s authority and clout. It ought also to send a strong message to trustees, sponsors and members that the issues of occupational pensions are being taken seriously.

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