Investing for DB pension schemes

[Alaric]

Would it require a law change?

It was a common practice for employers to suspend pension contributions in the 1980s and perhaps early 1990s. Some even returned surplus assets to the sponsor. So it used to be legal. A reason why some pension funds went into deficit is that they returned too much or didn't collect enough. Tax policy at the time as to impose charges if a scheme had "too much" in it.

[ChrisNix]

Would it require a law change?

It was a common practice for employers to suspend pension contributions in the 1980s and perhaps early 1990s. Some even returned surplus assets to the sponsor. So it used to be legal. A reason why some pension funds went into deficit is that they returned too much or didn't collect enough. Tax policy at the time as to impose charges if a scheme had "too much" in it.

WH Smith has liberated statutory surplus over last eighteen months. After tax surcharge of 35% (or thereabouts).

[ChrisNix]

The bailing out if it was required should have been met by the sponsor companies. The Bankof England, that is the taxpayer, should not really have been involved, except in so far as a disorderly market in gilts is not good for anyone.

And by the way, LDI in itself was not the issue. It was the leverage via derivatives that was introduced by ‘smart’ traders that caused the problem. As gilt interest rates rose after the mini budget, capital values fell, triggering margin calls. With no or not enough liquidity, pension funds had to sell assets, usually gilts, causing them to fall further and creating a truly vicious loop.

That is what Next was worried about but not many sponsoring companies seem to have seen the risks.

Dod

In fact, it might have made more sense for the sponsoring companies themselves to purchase LDI funds, seeing as they were the real beneficiaries.

[ChrisNix]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

I didn't say strategies. As I've said before, you don't see the wood for the trees.

I am familiar with all the rhetoric to justify the strategy, but the key bet is that LDI funds will gain when interest rates fall.

Lot's of other stuff around that, but in fact just a number of other bets which funds hope will go right, but are sold as part of the amazing package.

I don't know how many times you need telling. The majority of pension funds with LDI benefit when interest rates rise. You don't appear to see either wood or trees!

Seriously?

Moderator Message:
Personal 'attacks' are not appropriate on this site. Please stick to debating the topic (chas49)

the question boils down to:

Would a db scheme, which in February held nominal LDIs, have been better off now if it had realised the LDIs then and placed the funds in cash?

That's a yes or no question BTW.

Chris

[dealtn]

Some balance is required here.

Leveraged LDIs could be seem as a leveraged bet on longish interest rates falling.

Only by those that don't understand LDI strategies I'm afraid.

I didn't say strategies. As I've said before, you don't see the wood for the trees.

I am familiar with all the rhetoric to justify the strategy, but the key bet is that LDI funds will gain when interest rates fall.

Lot's of other stuff around that, but in fact just a number of other bets which funds hope will go right, but are sold as part of the amazing package.

I don't know how many times you need telling. The majority of pension funds with LDI benefit when interest rates rise. You don't appear to see either wood or trees!

Seriously?

Moderator Message:
Removed quoted text which has been removed (chas49)

the question boils down to:

Would a db scheme, which in February held nominal LDIs, have been better off now if it had realised the LDIs then and placed the funds in cash?

That's a yes or no question BTW.

Chris

Well you would need to define better off.

You would also need to describe "realising the LDIs and placed the funds in cash". In a margined interest rate derivative when you realise it it doesn't free up any funds. You have nothing to put in cash.

If instead of the question you asked you presented the following scenarios of a pension fund with investment assets and future pension liabilities, and the interest rate and inflation markets played out exactly as have happened since February (not known at that time, obviously) then:-

Scenario A do nothing
Scenario B unwind all LDI and do nothing with respect to other assets (having increased risk)

Then Scenario B would show a better balance sheet position now than Scenario A. Under alternative changes in the interest rate and inflation markets the reverse might be true (as it was for successive periods over the last couple of decades).

[Alaric]

Then Scenario B would show a better balance sheet position now than Scenario A. Under alternative changes in the interest rate and inflation markets the reverse might be true (as it was for successive periods over the last couple of decades).

There's a long standing piece of actuarial theory whuch says that if the discounted meaan term of a set of cash flows A is lomger than that of the set of cash flows B, then the set of cash flows A has a greater change in value than cash flow B when interest rates change.

So when pension funds are mismatched in the sense that their liability outgo is of a longer term than their asset income, then you will see that effect that they have a paper loss on a fall in interest rates and a paper gain on a rise. Over time what they can get on new investments will turn the paper loss or gain into money or lack of it on the table

[dealtn]

Then Scenario B would show a better balance sheet position now than Scenario A. Under alternative changes in the interest rate and inflation markets the reverse might be true (as it was for successive periods over the last couple of decades).

There's a long standing piece of actuarial theory whuch says that if the discounted meaan term of a set of cash flows A is lomger than that of the set of cash flows B, then the set of cash flows A has a greater change in value than cash flow B when interest rates change.

So when pension funds are mismatched in the sense that their liability outgo is of a longer term than their asset income, then you will see that effect that they have a paper loss on a fall in interest rates and a paper gain on a rise. Over time what they can get on new investments will turn the paper loss or gain into money or lack of it on the table

Yes but in this hypothetical world, someone else has created, time has only moved 8 months, and there are no new investments. In the real world of pensions however ...

[chas49]

Moderator Message:
All posters need to avoid personal insults/attacks.

The site rules include the following:

Robust debate is allowed, but it must remain polite and respectful at all times. Stick to the facts and argue the points discussed, rather than criticise the poster.

Posts which break the rules risk deletion without warning

[Alaric]

[

Yes but in this hypothetical world, someone else has created, time has only moved 8 months, and there are no new investments. In the real world of pensions however ...

I'm talking about what new investments will earn in the future. When the liabilities are longer than the assets, you may get a bit of cash flow from coupons and maturities received in advance of paying related liabilities. The valuation model assumes you would invest them at the rate used for the valuation calculations.

[Dod101]

I must say that I find a lot of pension stuff quite bemusing because only the hard assets held in a pension fund are real and true (on a particular day that is)

The liabilities have so many moving parts that refining them to one number is, at best, an estimate and nothing more, and they vary week by week, day by day. Obviously, in the big pension schemes it will be easier to arrive at a better estimate but that is all the liabilities are. Just think, mortality of the members, salary increases, investment returns, inflation rate, to mention just four moving parts, and I am sure there are lots more, over say the next 40/50 years?

I know well that we need a stab at the liabilities but it would be very interesting to return in say 30/40 years time when some of the bigger DB schemes are winding down to see how the funding actually worked out. Of course in the final years if not long before, the schemes will have been merged into a big insurance pot so I suppose we will never know.

Dod

[dealtn]

I must say that I find a lot of pension stuff quite bemusing because only the hard assets held in a pension fund are real and true (on a particular day that is)

The liabilities have so many moving parts that refining them to one number is, at best, an estimate and nothing more, and they vary week by week, day by day. Obviously, in the big pension schemes it will be easier to arrive at a better estimate but that is all the liabilities are. Just think, mortality of the members, salary increases, investment returns, inflation rate, to mention just four moving parts, and I am sure there are lots more, over say the next 40/50 years?

I know well that we need a stab at the liabilities but it would be very interesting to return in say 30/40 years time when some of the bigger DB schemes are winding down to see how the funding actually worked out. Of course in the final years if not long before, the schemes will have been merged into a big insurance pot so I suppose we will never know.

Dod

Many of those closed funds are maturing sooner than you think. You don't need to wait 30-40 years for the final liability (and it would be much later in some cases) to observe that run off.

[XFool]

So... To try and summarise, for we amateurs:

1. Back in the day, company pension funds invested entirely in safe UK government gilts.

2. Post WWII, in 1947, George Ross Goobey was appointed fund manager of Imperial Tobacco's pension fund. At that time, with a growing economy, the yield on UK government gilts was lower than that of shares. He persuaded the fund to convert almost entirely into equity investment. https://en.wikipedia.org/wiki/George_Ross_Goobey

3. From 1950s/60s up to the 1990s 'the cult of the equity' reigns supreme in UK pension funds.

4. November 1991, Robert Maxwell goes over the side of Lady Ghislaine

5. Pensions Act 1995, Following the Maxwell scandal, legislation introduces changes to laws on pensions. Followed by further legislation in following years. https://en.wikipedia.org/wiki/Pensions_Act_1995

6. Late 1990s, changes to accounting standards FRS17 and IAS19 put pension deficits on corporate balance sheets.

7. 1997, Paper 'The Financial Theory of Defined Benefit Pension Schemes' published "...arguing that liabilities were like bonds so could, and indeed should, be hedged." https://www.actuaries.org.uk/system/files/documents/pdf/financialtheorydefined.pdf

8. 1999/2000 Boots the Chemists moved their pension fund to almost 100% government gilts and bonds. Partly advised by Corporate Finance director John Ralfe.
See 'Immunisation Theory' https://en.wikipedia.org/wiki/Immunization_(finance) developed by Frank Redington and others https://en.wikipedia.org/wiki/Frank_Redington

"'Marking to market' accounting standards that highlighted the risks being run by defined benefit (DB) pension schemes, together with more rigid regulation, solvency requirements, dividend tax, low interest rates and improving longevity, have all contributed to DB pension scheme decline in the private sector."

9. 2001, Dot Com stock market crash, along with increasing longevity, caused DB funds to begin to close or switch strategy

10. Present day, Liability Driven Investment (LDI)
https://www.investopedia.com/terms/l/ldi.asp

A Brief History of LDI
https://www.ft.com/content/a86f410e-6a5d-467d-a1b2-cd6ab30ded0e

[ChrisNix]

I must say that I find a lot of pension stuff quite bemusing because only the hard assets held in a pension fund are real and true (on a particular day that is)

The liabilities have so many moving parts that refining them to one number is, at best, an estimate and nothing more, and they vary week by week, day by day. Obviously, in the big pension schemes it will be easier to arrive at a better estimate but that is all the liabilities are. Just think, mortality of the members, salary increases, investment returns, inflation rate, to mention just four moving parts, and I am sure there are lots more, over say the next 40/50 years?

I know well that we need a stab at the liabilities but it would be very interesting to return in say 30/40 years time when some of the bigger DB schemes are winding down to see how the funding actually worked out. Of course in the final years if not long before, the schemes will have been merged into a big insurance pot so I suppose we will never know.

Dod

The pronouncements of the PR will rather force schemes' hands, so we'll never really know.

We can only really see what worked well in past periods. c.f. e.g. George Ross Goobey.

Regulation shifts have changed the environment several times, and in the past decade hastened the closure of almost all private db schemes to future accrual.

USS looks set to continue, though.

Chris

[Dod101]

I must say that I find a lot of pension stuff quite bemusing because only the hard assets held in a pension fund are real and true (on a particular day that is)

The liabilities have so many moving parts that refining them to one number is, at best, an estimate and nothing more, and they vary week by week, day by day. Obviously, in the big pension schemes it will be easier to arrive at a better estimate but that is all the liabilities are. Just think, mortality of the members, salary increases, investment returns, inflation rate, to mention just four moving parts, and I am sure there are lots more, over say the next 40/50 years?

I know well that we need a stab at the liabilities but it would be very interesting to return in say 30/40 years time when some of the bigger DB schemes are winding down to see how the funding actually worked out. Of course in the final years if not long before, the schemes will have been merged into a big insurance pot so I suppose we will never know.

Dod

The pronouncements of the PR will rather force schemes' hands, so we'll never really know.

We can only really see what worked well in past periods. c.f. e.g. George Ross Goobey.

Regulation shifts have changed the environment several times, and in the past decade hastened the closure of almost all private db schemes to future accrual.

USS looks set to continue, though.

Chris

Yes, for now but they must have the same pressures as others but so long as they find the necessary funding they will continue I suppose.

Dod

[micrographia]

I must say that I find a lot of pension stuff quite bemusing because only the hard assets held in a pension fund are real and true (on a particular day that is)

The liabilities have so many moving parts that refining them to one number is, at best, an estimate and nothing more, and they vary week by week, day by day. Obviously, in the big pension schemes it will be easier to arrive at a better estimate but that is all the liabilities are. Just think, mortality of the members, salary increases, investment returns, inflation rate, to mention just four moving parts, and I am sure there are lots more, over say the next 40/50 years?

I know well that we need a stab at the liabilities but it would be very interesting to return in say 30/40 years time when some of the bigger DB schemes are winding down to see how the funding actually worked out. Of course in the final years if not long before, the schemes will have been merged into a big insurance pot so I suppose we will never know.

Dod

The pronouncements of the PR will rather force schemes' hands, so we'll never really know.

We can only really see what worked well in past periods. c.f. e.g. George Ross Goobey.

Regulation shifts have changed the environment several times, and in the past decade hastened the closure of almost all private db schemes to future accrual.

USS looks set to continue, though.

Chris

Yes, for now but they must have the same pressures as others but so long as they find the necessary funding they will continue I suppose.

Dod

Off topic again, but as it happens the level of USS funding has to be assessed every 3 years. After each valuation exercise it is decided whether benefits need to be adjusted (usually down, funnily enough) or employer and employee contributions have to change (they usually have to go up, funnily enough). On the face of it this is reassuring and fair and one would assume common sense is being applied. Longer life expectancies, post-Maxwell changes to legislation, fallout from a once in a century financial crash etc.

The last valuation was March 2020 at the height of the market impact of the pandemic. On the basis of which a £14 Bn deficit was reported and used to justify increased contributions and...well you get the picture. The Union, whose members are almost by definition not stupid, pointed out the weakness in this reasoning. Their objections were dismissed and the current wave of industrial action needlessly gained extra support. I'm still unclear whether USS were compelled by legislation to act the way they did regardless of the unusual circumstances the valuation was carried out under or if they simply used it as a convenient pretext to justify changes they wanted anyway. Why didn't they wait until the impact of the pandemic was a bit clearer before acting?

To absolutely no-ones surprise an interim valuation in March this year indicated that the deficit had dropped to £1.6 Bn as (primarily equity) assets had mysteriously increased in value by a third. The USS position was that in their opinion things were dicey before the pandemic and they stated in November last year in response to criticism (when as far as anyone knew the scheme was still in an enormous deficit);

"It should be clear that the prudent conclusions and outcomes we have reached regarding the overall contribution rate required under the 2020 valuation do not rest on the market values of one day. It is incorrect and misleading to claim otherwise."

A position supported by the Pensions Regulator. The fact that is was not clearly prudent to the employees affected by their actions was supported by the finding that by August this year USS now reckoned it was £1.8 Bn in the black, almost entirely due to the continuing rebound in equities. As we have heard in this thread, the schemes position should now be even better. Nevertheless, employees wage packets remain lighter than they were and their retirement prospects poorer.

USS hasn't ruled out improving benefits or cutting contributions in future should the next full valuation convince them that it is indeed in rude health when not in the middle of a massive but temporary equities crash. The cynical among the schemes membership note that changes that benefit them seem to happen a lot more slowly - if at all - than those that penalise them, which always seem to be urgent. Given the other pressures in the sector that are contributing to the unrest amongst employees, the even more more cynical among the schemes membership would not be surprised if any changes first took the form of a cut to the employers contributions.

Watching with interest, EEM.

[Alaric]

Given the other pressures in the sector that are contributing to the unrest amongst employees, the even more more cynical among the schemes membership would not be surprised if any changes first took the form of a cut to the employers contributions.
.

Have they been pocketing by use of LDIs, partcularly being able to gear up additional equity exposure? It can depend how they value the liabilities when they state a deficit, but if they can invest in equities at a positive real rate of return instead of indexed Gilts at a negative one, their funding position should improve with time.

[gpadsa]

Have they been pocketing by use of LDIs, partcularly being able to gear up additional equity exposure? It can depend how they value the liabilities when they state a deficit, but if they can invest in equities at a positive real rate of return instead of indexed Gilts at a negative one, their funding position should improve with time.

https://www.uss.co.uk/how-we-invest/where-we-invest says "£82.2bn in assets and our in-house investment management team directly manages almost 70% of these"

-13% borrowed for leverage
40% equities
28% private markets
26% index-linked gilts
7% gilts
12% other fixed income
---
100%

The donut graph at that url shows it better. About 1/2 of the 'private markets' = PE (https://www.uss.co.uk/how-we-invest/whe ... nvestments), the other 1/2 includes property & infrastructure lending. Plenty of both equities & index-linked gilts as mentioned in your msg
gpadsa

[XFool]

BT’s pension fund ‘fell by £11bn’ after mini-budget

The Guardian

Report from one of the UK’s largest schemes is an early indicator of scale of the financial impact on retirement funds

[ChrisNix]

Then Scenario B would show a better balance sheet position now than Scenario A. Under alternative changes in the interest rate and inflation markets the reverse might be true (as it was for successive periods over the last couple of decades).

There's a long standing piece of actuarial theory whuch says that if the discounted meaan term of a set of cash flows A is lomger than that of the set of cash flows B, then the set of cash flows A has a greater change in value than cash flow B when interest rates change.

So when pension funds are mismatched in the sense that their liability outgo is of a longer term than their asset income, then you will see that effect that they have a paper loss on a fall in interest rates and a paper gain on a rise. Over time what they can get on new investments will turn the paper loss or gain into money or lack of it on the table

https://www.ft.com/content/3859dc18-f15 ... e9a13c3976

[ChrisNix]

BT’s pension fund ‘fell by £11bn’ after mini-budget

The Guardian

Report from one of the UK’s largest schemes is an early indicator of scale of the financial impact on retirement funds

But the value of bonds needed to cash flow match the outflows fell by more, so on bond based measures funding improved.