Investing for DB pension schemes

[dealtn]

But to stick to the underlying point, even if there was/were a middle man/men involved, do you deny that a substantial amount ended up funding hedgies (and analagous structures) playing the carry trade?

Yes

Not sure where we go with this as quite a lot of anecdotal evidence out there.

Not sure you'd know, but who do you think were bidding for the 2073 index linkers on issue last year?

GBP1.1bn face issued at GBP3.9bn.

At the primary issuance?

I would have a very good idea what about you?

One of us set up a GEMM and personally managed my bank's book for all Linker Gilt issuance dealing directly with the DMO (including the book running detail) for approximately 10 years. I'm fairly sure when I look in the mirror I am not you. At the risk of publically revealing my identity you can count on your fingers the number of people alive that have set up a Index Linked GEMM.

I am happy to go wherever you want with this.

[ChrisNix]

Not sure you'd know, but who do you think were bidding for the 2073 index linkers on issue last year?

GBP1.1bn face issued at GBP3.9bn.

At the primary issuance?

I would have a very good idea what about you?

One of us set up a GEMM and personally managed my bank's book for all Linker Gilt issuance dealing directly with the DMO (including the book running detail) for approximately 10 years. I'm fairly sure when I look in the mirror I am not you. At the risk of publically revealing my identity you can count on your fingers the number of people alive that have set up a Index Linked GEMM.

I am happy to go wherever you want with this.

I wasn't trying to trick you: it was a genuine question, because I'm interested in knowing what types of investors were so keen to make such a spectacularly disastrous investment.

I'm all ears!

[ChrisNix]

By the same token, there is and was a time to take off hedges.

Not on the mandates those pension funds operate to, especially when the vast majority were under hedged.

Flawed mandates might have required retention, but there is no doubt that from a funding position closing out the LDIs was the right thing to do. And if one really understands the nature of the benefits the concept of under matching is a dubious concept.

The prime objective of DB schemes is to pay benefit outflows as they fall due. NOT to seek for the market value of their assets to mimic the hypothetical present value of their outflows were they investment grade bond coupons.

[Alaric]

The prime objective of DB schemes is to pay benefit outflows as they fall due. NOT to seek for the market value of their assets to mimic the hypothetical present value of their outflows were they investment grade bond coupons.

Once it became necessary to report pension scheme gains and losses in the sponsoring employer's books, I could suspect that the primary objective was lost sight of.

[Dod101]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds. I in any case, am rather cynical about the valuation of liabilities of DB pension funds because they can change so very rapidly, as I have said before, with the stroke of an actuary's pen. However, given that, Terry Smith seems to be giving me the clarity I was lacking in that if the pension scheme were only two thirds funded and had say £64 of assets against £100 of liabilities, then the fund is short of £36 which might be held as gilts to match the liabilities. No problem though according to sellers of derivatives. Just use the £64 to buy gilts as collateral to get the bank to buy another £36 of gilts to hold for it. Not called leverage of course, but a derivative contract, which had the same effect.

Hey presto that pesky underfunded pension scheme is now fully funded.

Dod

[Alaric]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds.

The full article is at the fundsmith website

https://www.fundsmith.co.uk/news/4594-f ... s-debacle/

He tells a story of involvement with a pension fund that invested in 20 shares rather than Gilts. A bit like a HYP then, but without a bias towards high dividend yields.

[Dod101]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds.

The full article is at the fundsmith website

https://www.fundsmith.co.uk/news/4594-f ... s-debacle/

He tells a story of involvement with a pension fund that invested in 20 shares rather than Gilts. A bit like a HYP then, but without a bias towards high dividend yields.

Thanks. Yes, the guy has clarity of thought which is always very helpful. I read recently that the drive to fully fund DB pension schemes arose from the requirement by Auditors or at least the accounting profession, to show shortfalls in pension scheme funding in the sponsoring company's books. That is all very well but the primary duty of DB pension schemes is not to run out of cash so as to be able to pay current pensioners and its second duty is to ensure that it has sufficient funds to meet its future liabilities. How though does it know them, since longevity, and investment returns are both (very) moveable feasts? That is why I am always cynical about these pronouncements about shortfalls or surpluses. It should be adequate for pension schemes to be 'adequately' funded without showing the calculations down to pounds if not pennies. It is accounting gone bananas, or you could call it kidology.

That is the root of the nonsense about derivatives and so on that has been the problem this last couple of weeks. At least that is my take. Anyone who knows better I would be delighted to hear from.

Dod

[Bobwood]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds.

The full article is at the fundsmith website

https://www.fundsmith.co.uk/news/4594-f ... s-debacle/

He tells a story of involvement with a pension fund that invested in 20 shares rather than Gilts. A bit like a HYP then, but without a bias towards high dividend yields.

The 'flaw' if I can call it that in Terry Smith's argument is that it assumes the DB scheme will be run-off (ie exist until the last member's benefits have been paid). Most schemes do not have this scenario as their planned end-game, rather they seek to be fully funded on a buy-out basis to enable such a transaction to take place, and LDI is the accepted route to this outcome.

Like everything TS says, it's an advertorial for Fundsmith.

[Dod101]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds.

The full article is at the fundsmith website

https://www.fundsmith.co.uk/news/4594-f ... s-debacle/

He tells a story of involvement with a pension fund that invested in 20 shares rather than Gilts. A bit like a HYP then, but without a bias towards high dividend yields.

The 'flaw' if I can call it that in Terry Smith's argument is that it assumes the DB scheme will be run-off (ie exist until the last member's benefits have been paid). Most schemes do not have this scenario as their planned end-game, rather they seek to be fully funded on a buy-out basis to enable such a transaction to take place, and LDI is the accepted route to this outcome.

Like everything TS says, it's an advertorial for Fundsmith.

To a point I agree with you, certainly re Terry Smith personally. Re LDI, I think you are falling into a trap in assuming that LDI is 'the' accepted route to winding down a DB scheme. Running down DB schemes en masse is a relatively new phenomenon and I am sure trustees are still trying to find the best way to do this. LDI arrangements are fine until they are not as we have found in the last couple of weeks. There are many ways to ensure that they remain fully funded, including maintaining 'traditional' fully funded arrangements, which 'risk' leaving a surplus when the last man/woman departs.

Dod

[Bobwood]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds.

The full article is at the fundsmith website

https://www.fundsmith.co.uk/news/4594-f ... s-debacle/

He tells a story of involvement with a pension fund that invested in 20 shares rather than Gilts. A bit like a HYP then, but without a bias towards high dividend yields.

The 'flaw' if I can call it that in Terry Smith's argument is that it assumes the DB scheme will be run-off (ie exist until the last member's benefits have been paid). Most schemes do not have this scenario as their planned end-game, rather they seek to be fully funded on a buy-out basis to enable such a transaction to take place, and LDI is the accepted route to this outcome.

Like everything TS says, it's an advertorial for Fundsmith.

To a point I agree with you, certainly re Terry Smith personally. Re LDI, I think you are falling into a trap in assuming that LDI is 'the' accepted route to winding down a DB scheme. Running down DB schemes en masse is a relatively new phenomenon and I am sure trustees are still trying to find the best way to do this. LDI arrangements are fine until they are not as we have found in the last couple of weeks. There are many ways to ensure that they remain fully funded, including maintaining 'traditional' fully funded arrangements, which 'risk' leaving a surplus when the last man/woman departs.

Dod

No Dod it's the opposite.

Sponsoring employers generally want DB schemes off their balance sheets and the quickest route to this is buy-out. For an insurer to transact the buy-out they will look for the scheme to be fully funded on a buy-out basis, and for the scheme to have a balance of its liabilities and assets, hence, LDI.

What Terry is proposing, retaining long-equity to deliver growth to meet the future long-term liabilities, would be the approach taken if the sponsoring company and trustees wish to run-off the scheme (ie keep it running way into the future in a position where it can meet all the liabilities until the last beneficiary ceases to be eligible for any payments). Few companies wish to do this, nor would trustees generally wish to.

re. your point LDI arrangements are fine until they aren't, as long as schemes have sufficient collateral (ie dry powder) to cover their positions, LDI is indeed fine, because even when assets drop in value dramatically, as we saw last week, the scheme's liabilities will have fallen by an even greater amount. They are directly linked. So ironically, most DB schemes will have an improved level of funding this week compared to say, a month ago.

[Dod101]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds.

The full article is at the fundsmith website

https://www.fundsmith.co.uk/news/4594-f ... s-debacle/

He tells a story of involvement with a pension fund that invested in 20 shares rather than Gilts. A bit like a HYP then, but without a bias towards high dividend yields.

The 'flaw' if I can call it that in Terry Smith's argument is that it assumes the DB scheme will be run-off (ie exist until the last member's benefits have been paid). Most schemes do not have this scenario as their planned end-game, rather they seek to be fully funded on a buy-out basis to enable such a transaction to take place, and LDI is the accepted route to this outcome.

Like everything TS says, it's an advertorial for Fundsmith.

To a point I agree with you, certainly re Terry Smith personally. Re LDI, I think you are falling into a trap in assuming that LDI is 'the' accepted route to winding down a DB scheme. Running down DB schemes en masse is a relatively new phenomenon and I am sure trustees are still trying to find the best way to do this. LDI arrangements are fine until they are not as we have found in the last couple of weeks. There are many ways to ensure that they remain fully funded, including maintaining 'traditional' fully funded arrangements, which 'risk' leaving a surplus when the last man/woman departs.

Dod

No Dod it's the opposite.

Sponsoring employers generally want DB schemes off their balance sheets and the quickest route to this is buy-out. For an insurer to transact the buy-out they will look for the scheme to be fully funded on a buy-out basis, and for the scheme to have a balance of its liabilities and assets, hence, LDI.

What Terry is proposing, retaining long-equity to deliver growth to meet the future long-term liabilities, would be the approach taken if the sponsoring company and trustees wish to run-off the scheme (ie keep it running way into the future in a position where it can meet all the liabilities until the last beneficiary ceases to be eligible for any payments). Few companies wish to do this, nor would trustees generally wish to.

re. your point LDI arrangements are fine until they aren't, as long as schemes have sufficient collateral (ie dry powder) to cover their positions, LDI is indeed fine, because even when assets drop in value dramatically, as we saw last week, the scheme's liabilities will have fallen by an even greater amount. They are directly linked. So ironically, most DB schemes will have an improved level of funding this week compared to say, a month ago.

Well I completely understand your second point because of course that is the whole point about LDI, but not many pension schemes will retain sufficient 'dry powder' as you call it and in any case how do they know how much is sufficient? So I still think that LDI is fine until it isn't.

As to your previous point, whether a scheme is bought out or not, it is still a scheme in 'run off' one way or another. For practical purposes, no sponsoring company is likely to hold a scheme in run off until the last pensioner pegs it obviously. I do not understand what is meant by the expression 'fully funded on a buy out basis'. Can you explain?

Dod

[Bobwood]

Just about to jump on a plane Dod so it will be brief, apols if that turns out to be bruque in any way.

Thye 'dry powder' will be highly liquid assets that can be used to purchase Gilts in the event of an unexpected rise in yields. Trustees and their advisers will agree what scale of rise is ever likely (in the worst possible unexpected circumstance) and ensure they have access to sufficient liquidity to cover this.

WRT funding on a buy out basis, Google is your friend as my cab has just arrived!

[ChrisNix]

I do not like Terry Smith very much but he has an article in the FT today which helps explain the problems with DB pension funds.

The full article is at the fundsmith website

https://www.fundsmith.co.uk/news/4594-f ... s-debacle/

He tells a story of involvement with a pension fund that invested in 20 shares rather than Gilts. A bit like a HYP then, but without a bias towards high dividend yields.

The 'flaw' if I can call it that in Terry Smith's argument is that it assumes the DB scheme will be run-off (ie exist until the last member's benefits have been paid). Most schemes do not have this scenario as their planned end-game, rather they seek to be fully funded on a buy-out basis to enable such a transaction to take place, and LDI is the accepted route to this outcome.

Like everything TS says, it's an advertorial for Fundsmith.

To a point I agree with you, certainly re Terry Smith personally. Re LDI, I think you are falling into a trap in assuming that LDI is 'the' accepted route to winding down a DB scheme. Running down DB schemes en masse is a relatively new phenomenon and I am sure trustees are still trying to find the best way to do this. LDI arrangements are fine until they are not as we have found in the last couple of weeks. There are many ways to ensure that they remain fully funded, including maintaining 'traditional' fully funded arrangements, which 'risk' leaving a surplus when the last man/woman departs.

Dod

No Dod it's the opposite.

Sponsoring employers generally want DB schemes off their balance sheets and the quickest route to this is buy-out. For an insurer to transact the buy-out they will look for the scheme to be fully funded on a buy-out basis, and for the scheme to have a balance of its liabilities and assets, hence, LDI.

What Terry is proposing, retaining long-equity to deliver growth to meet the future long-term liabilities, would be the approach taken if the sponsoring company and trustees wish to run-off the scheme (ie keep it running way into the future in a position where it can meet all the liabilities until the last beneficiary ceases to be eligible for any payments). Few companies wish to do this, nor would trustees generally wish to.

re. your point LDI arrangements are fine until they aren't, as long as schemes have sufficient collateral (ie dry powder) to cover their positions, LDI is indeed fine, because even when assets drop in value dramatically, as we saw last week, the scheme's liabilities will have fallen by an even greater amount. They are directly linked. So ironically, most DB schemes will have an improved level of funding this week compared to say, a month ago.

To clarify, most big companies with relatively small DB schemes see them as more trouble than they're worth, and are fairly indifferent to paying over the odds to getting the issue off their hands.

To fund to buy out (where an insurance company takes liability on to its books, assuming almost gilt yield low returns, less expenses and profit) is hugely more expensive than running an ongoing scheme, but many companies with plenty of spare financial capacity will continue to do so.

From a funding perspective LDIs fell into the trap, like many pension scheme derivative strategies, that consultants sold them as a great idea, but never gave any thought as to when the risks might outweigh the benefits. Hence few if any recommended unwinding in last year or so, when it became a racing certainty that they would harm funding.

How ironic it is that had such consultants been advising trustees over the last 50 years db benefits across the board would have been very materially lower.

But then a little knowledge is a dangerous thing.

[scotview]

Can a sponsoring company, with a healthy balance sheet, offer to transfer the remaining "value" of a DB pension to a SIPP for an individual DB pensioner (with the pension in payment) , to remove any future liability.

Is there a legal or statutory regulation that prohibits this happening ?

Hope this is a sensible question. Thanks.

[XFool]

FTSE350 pensions

https://www.barnett-waddingham.co.uk/comment-insight/ftse-db-endgame-step-forward/

DB endgame takes big step forward

"The last year has seen the biggest sustained improvement in the funding of UK defined benefit (DB) pension schemes since the global financial crisis."

[Alaric]

Can a sponsoring company, with a healthy balance sheet, offer to transfer the remaining "value" of a DB pension to a SIPP for an individual DB pensioner (with the pension in payment) , to remove any future liability.

Is there a legal or statutory regulation that prohibits this happening ?

You have to get the agreement of the individual and also a sign off by an IFA that the individual isn't disadvantaged by the change. It's unlikely an IFA would risk telling someone whose defined benefit was already paying that they would be better off in a SIPP. If the transfer value is sufficiently enhanced, there might be a better prospect with someone who had deferred benefits, those not yet in payment.

[XFool]

Can a sponsoring company, with a healthy balance sheet, offer to transfer the remaining "value" of a DB pension to a SIPP for an individual DB pensioner (with the pension in payment) , to remove any future liability.

Is there a legal or statutory regulation that prohibits this happening ?

You have to get the agreement of the individual and also a sign off by an IFA that the individual isn't disadvantaged by the change. It's unlikely an IFA would risk telling someone whose defined benefit was already paying that they would be better off in a SIPP. If the transfer value is sufficiently enhanced, there might be a better prospect with someone who had deferred benefits, those not yet in payment.

I am unsure but would assume it impossible to transfer a DB pension once in payment. Would there even be, at that point, a "transfer value" or "remaining value"?

[Alaric]

Would there even be, at that point, a "transfer value"

It's always possible to work out a value such that the total value for all individuals sums to the total quoted as liability value. There have been transfers to the likes of Legal & General to take over payment of the annuity. I don't know of any cases where transfer to a SIPP has been offered or allowed.

[tjh290633]

Can a sponsoring company, with a healthy balance sheet, offer to transfer the remaining "value" of a DB pension to a SIPP for an individual DB pensioner (with the pension in payment) , to remove any future liability.

Is there a legal or statutory regulation that prohibits this happening ?

You have to get the agreement of the individual and also a sign off by an IFA that the individual isn't disadvantaged by the change. It's unlikely an IFA would risk telling someone whose defined benefit was already paying that they would be better off in a SIPP. If the transfer value is sufficiently enhanced, there might be a better prospect with someone who had deferred benefits, those not yet in payment.

I am unsure but would assume it impossible to transfer a DB pension once in payment. Would there even be, at that point, a "transfer value" or "remaining value"?

A few years ago my former employer whose pension fund pays my DB pension, which has a fixed 3% annual increase, sought to buy out that pension and replace it with a level pension at a higher value. I believe that the intention was to buy that pension from the Pru or a similar insurer. My friends and I looked at the proposal and concluded that anyone living in excess of 5 more years would lose out. So in that case a transfer was certainly possible, although not to the medium you are considering.

TJH

[Dod101]

Just about to jump on a plane Dod so it will be brief, apols if that turns out to be bruque in any way.

Thye 'dry powder' will be highly liquid assets that can be used to purchase Gilts in the event of an unexpected rise in yields. Trustees and their advisers will agree what scale of rise is ever likely (in the worst possible unexpected circumstance) and ensure they have access to sufficient liquidity to cover this.

WRT funding on a buy out basis, Google is your friend as my cab has just arrived!

Having Googled 'funding on a buy out basis' it is no different from what I had understood so I am none the wiser and my views have not changed.

A company like Legal & General appear to be able to hold sufficient 'dry powder' so that they can use derivatives but I am not sure that many individual pension schemes can. So LDI seems like a hazardous way for them to 'fund' a pension scheme, I must say.

Dod