The Mercer Risk Transfer Conference Debate

Debating at the Mercer Risk Transfer Conference on whether “Bulk transfers are a waste of money”, William McGrath, ex CEO Aga Rangemaster and founder of C-Suite Pension Strategies said:

“Are bulk transfers a waste of money?  Absolutely.  Driven to sell, mostly for cash, liabilities valued at gilts plus a tiny slither to a buyer who has a different regulator and has an effective discount rate well over 1% higher and you are on a loser.  Don’t do it.  You are miscalculating member best interests.

Today I will look at what you can do and Con will discuss the Lunatic, Daft and Idiotic products that ate scheme cash and created a regulatory arbitrage.

Did regulators mean to create the risk transfer bubble?  Certainly TPR has played a blinder.  Acting as loss adjuster for PPF they persuaded the pension industry brilliantly that PPF did not exist at all.  That has meant that journey plans lost direction– what is the value gap for a member between the safety net of the massively overfunded PPF and that of FSCS, the unfunded, untested life insurers’ version?

Well, time and the Courts have trimmed PPF haircuts and our Moody’s Analytics model shows probabilistically it’s not much at all.  The differences reduce or even disappear if Government uses the PPF surplus.  Add a discretionary upside and the case for buyout now collapses. PPF meanwhile has run an impressive, sane investment strategy.  PPF is a great example of do as I do, not do as I say!  

But the numbers are needed with the FRC’s Technical Actuarial Standard 300 Version 2 requiring a comparison of bulk transfers with Credible Alternatives.  

Benefits payments from surpluses and the exercise of discretion are possible now with existing legal and tax technology and will get easier with new Government rules.  So it’s time to apply “opportunity cost” analysis to the bulk transfer fixation.  So why no numbers?  Well it’s not just about maths.  It’s about peace of mind, pats on the head and saying “fiduciary duty” again and again.  That provides scope to use legalise to waffle around awkward TAS300V2 comparisons.

Anyway. So what?  Exercising discretion requires sponsor Board approval and they just want to “get rid ASAP”.  No longer.  Public policy has changed.  I was an executive on public company Boards for 25 years.  Board members do not want to run the financial and reputational risks of being anti-Government policy when there’s money to be had.  So Run On 4 Good.    

You must be joking.  There’s a £50 billion a year business here for life insurers and consultancies have budgets to meet.  A conflict of interest?  No.  We don’t do conflicts of interest.  Actuaries use longevity tables set by a committee full of vested interests led by reinsurers.  Reinsurers who print money from longevity swaps are also parties to funded reinsurance.  Referee!

Yet Sammy will make his splendid case for syphoning more money from Scottish Widows to his favourite Singapore Sovereign Wealth Fund.  And what is the benchmark for a bulk annuity price?  Hard to tell.  Transparency is lacking and research on the track record of risk transfers is not what the consultancy sector dares to provide.  So how to judge the pricing that let Aviva make £1 billion pre-tax selling its own pension scheme to itself?  And what about the mysterious £10 billion NatWest / Rothesay buy in deal with half cooked disclosures.  A task for ARGA, when it heats up as a hot regulator, to put in the roasting oven.

So the message to the conference is “stop the waste”.  Here are our Run On aligned papers.  They include Concrete Proposals for Growth which Government wants and work in all stakeholders’ interest.  Our Run On 4 Good proposals have surety, surplus allocation and long-termist asset management in the Readymix but Government and sponsor additives can cement the deal.  The proof it works is the Aga Pension Scheme mix which reached full funding without resorting to vast corporate contributions by keeping to sound actuarial methods.  A far better recipe for all stakeholders. 

Endgames?  It’s not the end and it’s not a game of cricket.  But treated like one you can get caught out as beneficiaries realise the additional benefits lost from an early declaration.  They can appeal even after stumps.  In Rothesay Test speak that is “reverse swing regret risk”.

Enjoy a great Mercer risk transfer conference today even if life insurers are stars at Play Your Cards Right.  And tomorrow remember bulk transfers are a waste.  Your fiduciary duty 2025 : Ask relevant questions.  Deal or no deal.  No deal.  Pens down.  Don’t sign away the future.”

William McGrath spoke alongside Con Keating, founder of Brighton Rock.  He has long pointed out LDI hedged actuarial, not actual cash.  He points out conflicting Governmental data suggests the impact on scheme assets of the LDI crisis remains understated.  Rothesay and Just representatives responded.

The Aga Rangemaster pension scheme (formerly Glynwed) required considerable attention.  It was a key factor behind the sale to Middleby and it inspired an innovative structure to pre programme actuarial valuations and asset allocations. 

We described it at the time as “a deal nobody liked, but everybody could live with”.  It worked well.  Now, with my colleague Roger Higgins (ex KPMG and BTPS) as Chair, it is fully funded with a long term, cautious investment plan.  The key distinction from most schemes is it has never required big cash contributions.  Something of a triumph for all involved.  A summary of the  "Aga Pension Saga" is below.  

I have spent an extraordinary amount of time in recent years pointing out to the pension industry that their journey plans to buyout are ridiculously expensive and usually going the wrong way from member and sponsor perspectives.  In the last two years - as more have realised that a loss on assets does not disappear because it has been sprinkled with LDI holy water - public policy has shifted.  Finding new and better Credible Alternatives to bulk transfers has become a regulatory requirement.  The Government has also called for Concrete Proposals for growth.  Indeed, Aga’s experience provides a readymix plan.

William McGrath

The Aga Saga

In 2015 a Framework Agreement set asset allocation and actuarial assumptions for multi valuations.  Group guarantees were provided.
 
Aga Rangemaster numbers of note (focus on actuarial valuation years).

Agreed asset allocations throughout:

• Return seeking                           40%
• Matching assets (inc. property)  60%

 
2023 valuations showed a surplus.  No company contributions are expected from 2025.  Scheme / company can agree to move to a reduced discount rate with a long-term asset return at a premium to it and raised hedging levels.
 
Without the Framework Agreement, more “derisking” measures would have been required and far higher sponsor cash contributions.  Standard recovery plans would have run at over £30m a year.  The numbers show they would have been unnecessary.

How Excessive Derisking Came to Stimulate Economic Growth

In 1997 after years of steady growth in a high inflationary environment, most UK DB pension schemes were strong financially – almost too strong.  Some took contribution holidays.  Companies with large pension surpluses were acquisition targets.
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• Advanced Corporation Tax (ACT) credit provided a subsidy and had been material to the strength of UK pension schemes.  ACT was first cut back and then abolished in 1997.  The years of plenty were over.
• Actuaries’ valuation techniques using dividend yields for UK schemes’ liabilities made no sense once the credits went.  Change was required. 
• From 1995, Minimum Funding Requirements had already encouraged market pricing to be used.  Gilts were used post-retirement and equities pre-retirement.  By then accountants were pushing for schemes to lower equity risk and use high quality ‘AA’ bonds to value liabilities.  They also wanted DB schemes to be on the balance sheet.
• In a turf war with accountants, actuaries switched to using gilts plus a slither of added return as the discount rate to value liabilities making them more aligned to insurers.  Accountants did not follow.  So rival valuation systems were introduced which have cost pension schemes ever since.
• The idea of matching (good) and return seeking (risky) assets emerged.  The more matching the better.
• For companies, pension became a volatile accounting issue and a cost as actuaries responded to the long, fixed income bull market by asking for more money to feed their new valuation technique.
• The Pensions Act 2004 made it clearer that schemes had to fund more strictly.  TPR was created to drive for risk reduction to protect the new safety net – the PPF.  Funding to buyout levels became a requirement from 2005 in certain circumstances.  Section 75 debts and accounting volatility of schemes and cash contributions made Boards want to keep their distance from pensions.
• From 2007 onwards the idea of using derivatives and LDI rose with an influx of fixed income sales teams from investment banks (led by Redington) coming to the pension sector.  And finding consultants amenable and the markets lucrative.
• Derisking (meaning sell equities, especially UK equities, and buying more protection against interest rate falls) took hold.
• After a false start, Pension Investment Corporation and Rothesay led a new wave of life insurance vehicles intent on psyching trustees into extending investment derisking into “Risk Transfer Solutions”, which handed schemes’ responsibilities, in whole or part, over to them.
• TPR and PPF proved remarkably successful initiatives.  Governance improved; cash contributions by sponsors were remarkably high and investment portfolios were derisked.  PPF became well funded and very efficient.
• TPR and the pension consultancy industry came to believe that life insurers provided a “Gold Standard” and all should work to achieve it.  As with the Gold Standard in 1920’s, that had serious negative consequences.  Systemic risk in leveraged LDI when interest rate cycles turned and the concentration risk with a limited number of insurers was underestimated.
• Longevity trends had changed from 2011.  That suggested “wait and see” was a good approach, but by now the risk transfer industry was in a hurry to get hold of assets, so that was largely ignored.
• And so policy adjustments were needed after the great cash collateral crisis of 2022.
• Successive Chancellors started to encourage run-on and then to require schemes to evidence they looked at “Credible Alternatives” to buyouts.
• Corporate sponsors who had adopted a “get rid ASAP” approach saw HR, ESG and financial advantages in embracing their schemes and providing contingent third party back up.  They then ran the schemes on to benefit all stakeholders.  The chance to fund / improve current pensions was taken up.
• Trustees, seeing that PPF insurance covered ever more of pensioners’ accrued pensions, started looking at how a healthy scheme could add discretionary improvements in members’ best interests.  Discretionary improvement packages became common and Government added to flexibility.
• Trustees and sponsors agreed to reactivate schemes on a modernised (collective) defined contribution basis.  Members old and new benefitted from schemes allocating surpluses to them.
• Government saw that revived pension schemes were bringing more funds to invest in the UK economy and in productive asset investments.  They provided a tax incentive to encourage a new trend back to recycling money into the UK economy to great effect, revising the London Capital Markets.

The crisis of 2022 proved a wake up call.  Yet it actually highlighted that the UK had dealt rather well with the high liabilities arising from traditional DB schemes by early and firm action after 2004.  A bounce back from excessive derisking provided an opportunity.  TPR reset.  It also showed that, with straightforward Government policy and corporate mindset adjustments, it was possible for all stakeholders to benefit.  And they have.