Deficit figures – “as big and scary as they may be” – are not a good guide to understanding the problems facing the UK defined benefit (DB) pensions sector, according to the chair of a taskforce created by the country’s pensions association to untie the “Gordian knot” of challenges in the system.
Presenting the interim report of the taskforce yesterday at the annual conference of the Pensions and Lifetime Savings Association (PLSA), Ashok Gupta (pictured) said “the DB sector has a problem” but that it is “not a problem you can understand just by looking at deficit numbers – big and scary, and wildly fluctuating, as they may be”.
A better starting point, he said, was to understand the risk that “really matters” – namely, the risk to members’ benefits.
He later highlighted the volatility of scheme deficits as problematic in that a desire to reduce the volatility encourages sponsors to try to match assets and liabilities and to “take investment risk off the table”.
This “derisking nudge” is reinforced by other nudges, said Kupta, such as the belief that it is what the regulator wants, but he added that, overall, less investment risk only serves to “lock in the deficit and bake in a longer recovery period”.
In the end, risk has just transferred from investment risk to covenant risk, he said.
Defined benefit pension schemes are capable of bearing more investment risk, he added.
On a different conference panel, Sorca Kelly-Scholte, head of the EMEA Pensions Solutions & Advisory at JP Morgan Asset Management, said deficit headlines were “at best distracting and at worst can drive poor investment decisions”.
She said using a broader-based valuation framework than a Gilts-based one could help stabilise balance sheets.
One of the remedial actions that the PLSA DB taskforce has proposed is consolidation, saying the current system – with nearly 6,000 DB schemes – is too fragmented.
The reform in the local government pension scheme (LGPS), where the 89 funds are forming eight asset pools, was flagged as a possible model for the private sector DB sector.
Tim Sharp, policy officer in the economics and social affairs department at trade union TUC, suggested investigating whether “we can replicate in private sector DB some of the work we’ve seen happening in local government pensions” as a means of achieving economies of scale.
Different models would need to be explored to see how consolidation might be achievable, he said.
It could involve merging schemes or the government’s taking a role in “ensuring schemes have access to large investment pools”.
Gupta acknowledged asset consolidation as a possible way forward but said “the real win comes if you can also consolidate liabilities”.
This, he added, “takes you down the route of benefit flexibility”.
Reacting to the taskforce report in an e-mailed comment, Marcus Fink, pensions partner at Ashurt, said allowing schemes to pay less generous inflation rises could be a way forward as long as the power to do so was tightly controlled.
“The DB framework is premised on safeguarding historic benefit entitlements and rightly so,” he said.
“However, allowing some flexibility to alter the level of inflationary increases when pensions come into payments could mean the difference between a distressed company failing or securing a future for itself and its employees.”
Janet Brown, partner at Sackers and a member of the PLSA DB Council, said the taskforce’s “diagnosis” showed that DB schemes were under pressure for a number of complex reasons.
“Questions abound, and it may be that, while RPI/CPI gets a lot of attention, there are different solutions for different schemes,” she said.
“All involved need to be prepared to think more widely about DB schemes, including in the context of the economy, in a given employer’s remuneration package – noting the tension with employees with DC benefits – as well as how the industry is regulated.”