The end of the beginning: Private defined benefit pensions and the new normal

Report launch: ‘The End of the

Beginning? Private defined benefit

pensions and the new normal’

18th January 2017

This event is kindly supported by Ince & Co

Twitter - #DBDeficits

Welcome

Baroness Sally Greengross

Chief Executive

ILC-UK


#DBDeficits

Presentation of research

Ben Franklin

Head of Economics of an Ageing Society

ILC-UK


#DBDeficits

The International Longevity Centre-UK is an independent, non-partisan think-tank

dedicated to addressing issues of longevity, ageing and population change.

The DB private pensions challenge

Ben Franklin and Dean Hochlaf ILC-UK

follow us on twitter: @ilcuk @bjafranklin @dhochlaf



What am I going to cover?

• Approach

• Background

• What can we read into large numbers?

• What are the “real” issues?

• The impact of the macro environment

• What can we do about deficits?



Approach

• Private sector DB has faced big headlines and

policy interest.

• Two schools of thought:

1) Rising deficits represent a “real problem”

with firms struggling to meet their pension

obligations. Urgent action required.

2) Deficits are a crude actuarial construct and

the problem is not real but “imagined”.

Urgent action not required.

• Our report tries to take a step back to see the

wood from the trees in order to take a nuanced

perspective.

• Intended as a discussion paper rather than a

technical report.



Background: DB schemes have closed to new members

DB scheme by status



As overall deficit rises

DB pension assets and liabilities



What can we read into large numbers?

• Pension scheme liabilities valued on basis of safe assets such as

government/corporate bonds irrespective of actual investment strategy.

• Scheme deficits therefore highly sensitive to fluctuations in bond yields.

• While real yields on government bonds have been negligible since the crisis, UK

pension funds have been generating returns in excess of 5% per annum over the last

decade.



Proportion of schemes in deficit



However, DB funds are increasingly investing in fixed income assets

Asset allocation



But there are “real” problems for some with real

world implications

• Harrison and Blake have estimated that between 10-17% of schemes are in

serious risk of default.

• At the upper end this equates to about 1 in 6 private sector schemes (1000

overall).

• DB Taskforce’s interim report estimated that individual members of these

schemes stand a good chance of losing nearly 20% of their expected benefit



And whether imagined or real, plugging DB deficits likely to have

prevented some reinvestment in current workforce

Cumulative growth in employee compensation by type



Wages as a proportion of total compensation

Hypothetical: what if money used to plug deficit had been reinvested in

wages…wages 6% higher by 2015!



Continuing to fund DB but not DC leads to questions about intergenerational

fairness

Average contribution rates to occupational schemes



Will the macro environment shift back in favour of DB pensions?

• Despite DB schemes closed to new members, rising longevity means that, on a

conservative basis there will still be over 3 million recipients in 2060 and 1

million in 2070.

• Current economic weaknesses including low real interest rate may be structural

not cyclical.

• Driven by reduced Total Factor Productivity and global population ageing.



Are we in the new normal?…it’s a feeling that’s hard to shake

Source: OECD and author’s calculations.

Notes: Returns are adjusted for inflation using national CPI - all items.



Source: ILC-UK calculations and Bank of England, Three Centuries of Macroeconomic Data.



What can we do about it?

• There are alternative approaches to measuring DB scheme deficits. And there are technical

solutions for some trustees and sponsors to use capital markets and insurers to take on board

longevity and interest rate risk.

• But for some schemes, neither new measurement nor technical solutions will suffice.

• For some schemes, a choice will need to be made between increased contributions from the

employer, or the member accepting less by way of pension income. Both of which will come at

a cost.

• Who should bear this cost is a tough question, but we think a good starting point would be to

ensure the regulatory architecture allows for more flexibility for trustees to take a pragmatic

approach when faced with a crippling scheme deficit.

• The current focus on securing full member benefits may not be possible for some schemes, and

it is better to try and deal with such situations sooner rather than later as argued by Harrison and

Blake.

• But in the medium to longer run there must be greater recognition of the potential opportunity

costs of continuing to prop up ailing schemes which may necessitate more radical action.



Many thanks

Ben Franklin and Dean Hochlaf

International Longevity Centre - UK

02073400440

Twitter: @ilcuk @bjafranklin

Response to research

Douglas Anderson

Partner

Hymans Robertson


#DBDeficits


Professor David Blake

Director

Pension Institute, Cass Business School


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Lawrence Churchill

Chair

Pensions Policy Institute


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Jennifer Donohue

Partner

Ince & Co LLP


#DBDeficits

Discussion and Q&A


#DBDeficits

Close

Baroness Sally Greengross

Chief Executive

ILC-UK


#DBDeficits

Report launch: ‘The End of the

Beginning? Private defined benefit

pensions and the new normal’

18th January 2017


Twitter - #DBDeficits

Economy & Finance

The end of the beginning: Private defined benefit pensions and the new normal