“The Use of Longevity Swaps and Buy-Ins, and Other Unforced Errors” is a research paper from C-Suite Pension Strategies.

C-Suite looks at specific cases of risk transfers by DB pension schemes.  The work indicates :

• They have been costly and poorly timed.  Many are causing large losses.
• Transparency is not a priority for sponsor or schemes, with transaction details limited from the start and with obfuscation in the approach in subsequent sponsor financial documents.
• “Other Comprehensive Income” is used to avoid transactions impacting earnings (and the willingness of sponsors to undertake transactions at all).
• Life insurers have a regulatory arbitrage advantage and as sponsors hurry to cover up write offs, life insurers book profits on their side of the deal.

A conclusion is that heeding the Siren calls of the risk transfer industry can sound an unfortunate endgame to pension Odysseys.
The downgrades to life expectancy to come in 2023 will add to the impact of interest rate increases and will make deals look worse still.

“Get rid journey plans” remain dominant. More unforced errors will follow if the take away from the leveraged LDI crisis is to sell illiquid investments at the wrong time to protect a flawed strategy in which interest rate risk elimination is the absolute requirement.  

The financial impact needs watching.  C-Suite intend to track the data being published in 2023 by selected Groups with pension schemes on a derisking journey to see how their position has changed and what are the explanations provided.

The Risk Transfer Industry developed by life insurers and investment consultants is a highly successful feature of the pension provision.  Its role warrants sceptical analysis.  Consultants should apply their impressive marketing resources to publishing data on the financial impact of the deals and strategies they advocate.

Trustees have come to believe that they must reach the Gold Standard of buyout. Buy -ins and longevity swaps are just part of the process.  That pension values have fallen in real terms with inflation should be addressed.  What now is in members best interests?  That discretionary increases are possible is not even an industry debate.  Members, many trustees consider, should be grateful for what they have.  Yet it has been the derisking expectation set by the industry on their behalf that has made DB schemes into a legacy problem.  The pensions “Gold Standard” does not have 24 Carats.

“Derisking techniques are risky and come at a considerable opportunity cost.  Greater transparency is much needed.  It all shows it is time for a rethink.  Stable, long-term strategies remain the way to protect members – particularly in inflationary times”  William McGrath

Join us for a presentation on the paper in “Discretion is the better part of value” on 7th March 10.30am on Pensions Playpen.

DB pension peace of mind comes from inflation protection, not always from a sale to a life insurer.

The DB pensions industry has a largely settled opinion that “derisk and get rid” is the right journey plan for most pension schemes.  Members are told that here is “peace of mind” and that buyouts are the Gold Standard.  This approach benefits actuarial consultants and life insurers.  

Scheme members, current employees and scheme sponsors should all look harder at the alternative option of scheme revival on a modernised basis so it can operate in all stakeholders’ interests and over the long term.

Members should be asking more challenging questions of their trustees.  Inflationary times may lead them to have a new view of their best interests and the security of their pension seen in real value terms.  There is a cap on payments – usually at 5% and inflation is 10%. It is what the pension buys not the nominal amount that counts – as the Goode committee pointed out in 1992.

The risk assessment for members needs to be rerun.  The downside is modest and measurable.  There is the fully tested safety net of the well-run, well-funded PPF.  It covers a large, increasing proportion of a pension.  How the untested, unfunded Financial Services Compensation Scheme works is currently the subject of a Government review. With a buyout access to discretionary benefit improvements goes.  The link to their former employer ends and the investment policies pursued are out of members’ control- just as ESG considerations come to the fore.  

Solvency II replacement is much debated and creates uncertainty around concentration and systemic risk. There are also profound questions over future pricing as Government initiatives take hold.  They are designed to improve pricing and increase competition. Wait and see is the sensible response.

Meanwhile corporate and member agendas have to move on. Most sponsors have committed to high standards of ESG.  Pensions is a test case of those policies when in action.  Does the large investment portfolio align with their green agenda?  Do they see the scheme’s role in looking after the interests of former and current employees as important as their ESG statements indicate.  Sponsors should be encouraged to stay the course and be leaders.

C-Suite Pension Strategies shows how available products can be combined to produce better outcomes.  But what is really needed is for members and sponsors to question the negative pension sector mindset.

Transparency is needed.  The losses arising from derisking are hidden away in sponsors’ accounts where they do not impact earnings.  This means Schemes misreading of financial markets and longevity trends does not see the cold light of day.  Certainly, the case for spending large sums on “derisking” from the members’ perspective should be restated more urgently cogently. And shareholders should wince at how their money has been spent.  Consultants should be expected to provide data on actual transactions.

Current markets provide a good test case.  Interest rate rises should have reduced actuarial liabilities – more scope for improvements?  But not so fast.  Matching asset will have fallen heavily in value.  The scheme may be forced to sell return seeking assets to meet cash collateral calls under LDI programmes.  Ironic if risk reducing measures stand in the way of discretionary payments to members.
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“Decommissioning” is very often not in the best interests of members and does not provide “peace of mind”.  When the Boards of sponsors embrace the schemes and do not abdicate responsibilities, a new and better settlement can emerge. When there is time made available all stakeholders benefit.

No discretionary increases while inflation reduces the value of pensions? Members should consider their position and revolt.  Current employees should ask for surpluses to be used to boost current provision.

C-Suite Pension Strategies has looked into a number of corporates and their pension schemes.  The gap is frankly wide between the corporate rhetoric on ESG and the trustee reality on pension funding.
Contact us to discuss the findings.

A new Boardroom led ethos reflecting its stated strategies would close the gap by giving trustees a modernised remit. 
End the endgame.  Link the past to the future.  All stakeholders benefit.

• Are discretionary benefit improvements possible?

Yes if agreed by all parties.  Few trustees ask for them.  When they do it’s usually without providing a package to entice the sponsor into being supportive.  High inflation rates may change that attitude.
Solvency II / longevity / inflation are uncertainties:  Buyout now?Wait and see.  Action now is a gamble on political decisions yet to be taken.  Apart from weaker Solvency requirements, known information means longevity tables when updated will reduce liabilities.  All round the costs of buyouts should fall.

• PPF vs FSCS safety nets:  What is the gap?

Modest upgrade in safety net from the well funded, well run PPF to the unfunded, untested FSCS provides almost the entire focus of the pension risk transfer industry.  Transparency:  An assessment of the value is needed.

• Who controls assets post a buyout deal?

Members lose all control over who provides their pension.  Input into what the investments are from an ESG perspective is lost.  The recent Prudential appeal decision means that anybody convincing the Prudential Regulatory Authority (PRA) “their money is good at the bar” can provide your pension.

• Solvency II:  How impactful?

The impact cannot be known.  The CEO of PRA thinks it is a “once in a generation event”.  The PM and Chancellor consider it a major opportunity.  Acting now is a bet on the outcome of fierce Government / PRA / Association of British Insurers debates.

• Is selling assets to fund collateral calls going on?

The sharp interest rate moves will require collateral pools to be increased.  Forced and untimely asset sales have been needed.  Con Keating calculates there are already massive losses arising from forced selling.  Certainly time to (re)read the legal agreement behind LDI.

• Longevity tables:  Are they fit for purpose?

Covid and the 2021 Census are not covered by the CMI tables.  Series 3 tables use data from 2011 to 2016.  CMI has recently confessed some of the input data was wrong.  Long term rates of improvement still “fix the figures” by building into minima even though there have been no discernible improvements for over a decade.

• Longevity swaps:  So far out of the money?

The risk transfer industry’s punt on longevity has provided insurers and reinsurers with profits so large it is an embarrassment to them.  The losses for schemes and their members structured into buyins is still not discussed.  Greater transparency needed.  

• Is better funding after the step up in interest rates a trigger for sale to a life insurer?

A scheme / sponsor that can afford a buyout can afford to run on with added back up.  It is time for all stakeholders to reflect on what they want to achieve.

• Do ESG and Section 172 matter now to corporates?

Most corporate Boards have become enthusiasts for ESG and S172.  The standard cold shoulder offered by trustees in Statements of Investment Principles to ESG / Impact Investment comes across as dated.  It plays up a narrow interpretation of fiduciary responsibilities.

• Life insurer profits:  Why so high?

The value of Rothesay and Athene (USA); the profits of Pensions Investment Corporation and the surpluses of the PPF show just how value has been transferred out of schemes to the insurance industry over the last decade.

• Members’ views:  Are they ever considered?

Members’ interests have been in accrued benefits being paid.  It is hard to impact on regulatory work to ensure that they are paid.  Now “independent” trustees are largely from actuarial consultants and legal firms and they look to the view of their industry and professional bodies for a lead.  The push to abolish member nominated trustees is a reflection of the gap between trustees and members.

• Should member votes / consultations ahead of annuitisation be required?

If trustees had to win a vote / consultation before a buyout there would be a healthy change in attitude all round.  The “added security” / “peace of mind” mantra would be tested - and replaced with the need to show it is the best, not the easiest most rewarding option for professional and insurers.

Members should consider their position and revolt.

The position of C-Suite Pension Strategies is that corporate sponsors need to “get stuck in”.  The industry is not working in either their or in scheme members’ best interests.

The 2004 Pensions Act introducing TPR and PPF was a success.  Higher cash funding and derisking have left many schemes well placed.  Schemes should now be revived on a modernised (C)DC basis.

The trigger for change is the ESG commitment of Boards and the risks in greenwashing.  Pension funding strategies provide excellent test cases of rhetoric against reality.  At the same time members should revolt.  With inflation higher than most scheme increase caps, then annuitisation is not a path to “peace of mind”.

Overall “endgame” thinking is inappropriate.  It is not the End: it is not a Game.
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A change in the premise of corporate sponsors to embrace from “get risk ASAP” can be transformational, showing how it is not too late for many sets of trustees to reengage with members and provide them with better outcomes.