Life Lessons for Corporate Sponsors of DB Pensions

The cost of the outsourced products was ridiculously high.  Bring it all in house and control the development of the products through an off-balance sheet vehicle.  Worked brilliantly and we trusted it to deliver. Within years the products provided a real competitive advantage keeping overall costs well down.  They were reputationally enhancing with employees and with institutional investors.  And the products qualified for tax breaks.  For a generation all went well.  Big benefits at little cost.  

Within a few years at the turn of the century our vehicle became a big problem.  It had to be a sub.  It came on balance sheet and its tax breaks were abolished.  The raw material costs skyrocketed.  And the products in place had much longer repair and maintenance contract costs than anyone had expected.  There were timeless commitments made without proper consideration.  Panic.

Cuts were made wherever possible and alternative products introduced.  The original products were caught by ever tighter Government regulations and admin costs.  Suppliers who had worked happily to create the products now turned tail and wanted to be paid decommissioning costs.  The sub was taking on water and eating cash. We were pumping as fast as possible. It was hated. Anything to get rid ASAP without more damage became the settled Board plan.  Few products said “legacy problem” (not this Board’s fault) so clearly, other than the environmentally contaminated manufacturing sites.  Endgame needed.

Then product managers were excited that new sophisticated treatment fixes had come on the market which neutralised the design flaws.  They were ultra-expensive and crystallised vast liabilities, but they were a stop loss.  Our suppliers recommended them. They said regulators approved of them and everybody in our industries was piling in.

And what was even better was that highly plausible, well-spoken salvage teams came in to buy the sub even if it was at ransom like prices.  But the cost was just out of reach.  Worth saving for harder still.  Then the product fix blew up - it too had such a bad design flaw that even our suppliers were embarrassed for recommending it.  Looked like our sub and many others would sink.  There was a Bank bail out.  We knew we had been done again.  Wrong coordinates on the journey plan.  Rethink.

We realised our suppliers were good friends of the salvage teams who themselves lived in luxury and had plenty of offshore locations where they refurbed subs and made great profits.  Government saw that it was its regulators and rules that had caused a great deal of the problem.  Indeed, the penny dropped that once the initial design flaws had been dealt with, the right approach had been to stand firm and do nothing.  What is more all those competitors who had not overshot on the derisking programmes were well placed now to obtain benefits from an investment bounce back as new improved modernised versions of the products became available.  
​
The circle of life. Once again, we decided to take pension provision away from the clutches of over mighty life insurers and look at our sub’s products and prospects as we would any other subsidiary.  And the good news is that both our former and our current employees, and our shareholders will benefit.  The original over-exuberance gave rise to many traumatic years but before all the value was squandered the Board found a way to Sail On 4 Good.  We love our sub again.  It's our ESG worked example.  It had just been misunderstood.  Life lessons were learnt.  The parable of the sub.

Defined benefit pension schemes were a major force for good for a generation, providing secure pensions, funding corporate development and boosting the City. By the late 1990’s some switch from equity to bonds was needed. Tax incentives and actuarial methods had pushed equity exposures too high. But the subsequent derisking overshoot proved costly and unnecessary for DB pension schemes. Now its all about “the endgame”.

The big winners have been life insurers; fixed income sales teams and actuarial consultants. Employers have been “suckered” and “bullied” into overfunding schemes. Employees, past and present, have seen what for most were remote problems, solved to a fault – precluding any discretionary upside for them from surpluses.

We are where we are. But giving yet more riches to life insurers and their mysterious off-shore re-insurer partners is not for the best. Instead, Run On 4 Good. That means a new framework and package of proposals to meet all stakeholders’ interests. And the key is corporate re-engagement. Trustees and their lawyers agonise themselves into super caution because of the lack of relevant statute and the hazy nature of the case law. The answer is to change the question rather than seek another “maybe” answer. Corporates provide the modest added contingent sums to cover worse case scenarios. Then reset to a more positive, mainstream, run-on agenda.

Sunny Uplands Are Now Available

Expect investment returns and actuarial demographic prudence to mean the DB fund returns 2% more than the actuarial low dependency model a year. 

Ask for new asset management plans. Invest with a growing proportion of assets allocated to UK and Impact funds with longer time horizons. That can mean 1.5% to 2% more return. Asset managers will be delighted with a competition for a long term deal to look after the money.

Exercise discretion. Plan for the scheme to pay all its own costs (including new sponsor guarantee costs recharged) and then make added payments to pensioners (over 0.5% of assets a year allocated will equate to a 10% increase a year) with the rest funding and improving current pensions.

Sponsor arranges a fixed sum surety bond to cover the remote chance of its demise or it not making contributions calculated on the basis of set actuarial and investment strategy assumptions.

Ask the game-changing question

“What are the conclusions of the Technical Actuarial Standard 300 Version 2 exercise?”

Arrange a TAS300V2 Exercise. It is Compulsory and Strategy Changing

TAS300V2 is compulsory. Actuaries have to research and evidence bulk transfer vs run-on options. For many trustees and sponsors the data will be alarming and strategy changing.

Our partners provide TAS300V2 exercises and viable alternatives to risk transfers – introducing compelling new strategies. Get in touch to explore further.

TPR played a blinder.  It has a role to reduce the risk of calls on PPF.  So it convinced the pension industry to ignore PPF's existence even as sponsors funded it.  Great loss adjuster work.  Helps the risk transfer industry.  But why did all those clever pension lawyers and consulting actuaries fall for it?
 
Now public policy is changing and TPR has moved on.  Paragraph 64 of “The Funding Regime” section of the new DB Funding Code sets out a sensible position, which was probably always the case.  How to see the PPF?  The reality remains the same.  It's the spin that's changed.  And why has the policy changed?  Looks like someone has been checking precedents. 

Referring to the case of Hope-v-Independent Trustee Services : 2009, Para 106 / 119:

Paragraph 64 means that in TAS300 V2 actuarial exercises the probability of loss and gain can be assessed without a folklore-based assumption there is no safety net.
 
“64. When performing their duties under Part 3 of the Pensions Act 2004 , trustees should not take advantage of the existence of the PPF as a justification for acting in a way which would otherwise be inconsistent with those duties.”
 
PPF is a success and no longer needs its minder.