Tag: PPF

Consulting firms reply to the WPSC Inquiry

The Work & Pensions Select Committee (WPSC) Pension Protection Fund and Pensions Regulator inquiry consultation certainly attracted a good number of responses. I count almost a hundred in that list and presumably not all are yet published!

Most of the major investment & actuarial advisory firms are represented there, as well as  PPF and The Pensions Regulator.

Reading through the submissions of all the investment advisory firms (yes, I really did!) I must admit was struck by the quality of the submissions, the level of thought that had clearly gone into them and the ordered and lucid way in which arguments were presented. I didn’t agree with everything that was said by our competitors (you’d expect that) but I was impressed with the quality.

I’ve tried to summarise each of them below, naturally these are through the lens of my own reading and interpretation. If you think I’ve got any of them wrong, please let me know!

At the end I’ve tried to draw out the questions on which that group of respondents are clearly divided.

I’ve ordered the summaries below on an approximate scale of suggested change level, from those that argued for least >> most


Big picture Hymans believe that the current regime is fine, there is not an issue with affordability subject to giving schemes and sponsors “time to heal”.

“Most schemes are well managed and should be able to pay benefits in full

Hymans would not propose any changes lest these have unintended consequences and damage the functioning of the majority of schemes. Floated the idea of conditional indexation in stressed situations but highlighted the need for “watertight safeguards”. On the regulator’s powers:

“The regulator has adequate power. It’s wrong to assume that committing more resource to the regulation of DB schemes will improve outcomes for pensioners. It might actually exacerbate the problem – because more onerous regulation could make DB provision more difficult for employers.

Hyman’s noted that the PPF has been managed in a sustainable way and indeed provides a good risk management model for all pension funds.


Provided a timely reminder that the PPF itself is both necessary and stable – with a growth in assets to £23bn but a funding level of 116%, and total benefits paid out to members of £2.4bn.

Much of the response concerned considerations regarding the future level of the levy, describing enhancements to the models used and refinements based on data gained, particularly in taking a different approach to small companies compared to large ones. Improving predictiveness of models, using different variables.

The PPF indicated a belief that sponsoring employers have sufficient cash and financial strength to shorten recovery periods, and discussed their aggregate modelling of the number of schemes predicted to enter the PPF:

“. Indeed our modelling projections would indicate that given the strength of employers in the median case the vast majority of schemes should be sufficiently funded to pose little risk of making a claim on the PPF by 2030 (with less than 700 schemes falling into the PPF in in the median case by that time as against around 850 to date).

The PPF would support a more interventionist role from TPR, for certain categories of scheme, with the goal of tackling risks to member benefits. In particular PPF believe that for stronger sponsors shorter recovery periods should be targeted (interesting, this is the one area where the PPF appear at odds with TPR, with TPR indicating their willingness for more flexible terms for strong sponsors). PPF believe restrictions on recovery periods and “back-end loading” of contributions would be appropriate.

For stressed schemes – the PPF  suggests intensive scrutiny and consideration of the options for restructuring the scheme. They made a case for TPR to have the broad power to trigger the wind-up of schemes with request of PPF or the trustee. In transactions PPF believes avoidance powers could be enhanced by better targeting and faster implementation. Duties placed upon employers and trustees to engage with TPR would be appropriate.

PPF noted that options for scheme consolidation should be considered. Highlighted their concern at the suggestion of new business models that might allow a scheme to continue without a sponsor.


The Pensions Regulator (TPR)

TPR believe the current regime is operating as intended and most pension schemes are affordable for the majority of employers (backed up by data on ratio of contributions to dividends). Made some suggestions on how TPR could be changed with the benefit of experience: more powers to compel individuals and organisations to give TPR information and submit to scrutiny (including civil powers). More timely actuarial valuation information (narrowing the 15 month window in acknowledgement of technological enhancements). Powers to be more prescriptive on the overall funding and investment outcome, rather than focusing on individual parameters such as length. Shifting the burden of proof to schemes to justify long recovery periods etc. Mandatory clearance of corporate transactions could be considered (the current system being voluntary), which could extend to all actions that potentially weaken the standing of a pension scheme (eg dividends, share buybacks). Suggested enhanced whistle-blowing procedures could also be considered.


We stressed the importance of considering all this from the member perspective, and emphasised the benefits to schemes of enhanced governance (which many UK schemes are of insufficient scale to deliver). We also highlighted the existence of a number of success stories around the industry that we believe through better knowledge-sharing of best practice. We acknowledged the tricky balance that regulation must strike between security for members and sustainability of firms, noting that it is usually in the best interests of pensioners to continue to have an ongoing firm backing the scheme. We argued for small-scale changes to existing regulation to strengthen the hand of trustees in funding negotiations, provide more guidance on parameters and shift the responsibility to sponsors to offer additional security in the case of lengthened recovery plans.


LCP’s response took things back to the highest context level, highlighting the key tensions and spelling out the fact that there aren’t any easy political choices. LCP believe a “significant minority” of schemes will be unable to pay full benefits. Resolution will require political change now which may be painful in the short term, but carry long term benefits for security of pensioners. Setting out the three different political options facing the government LCP described the broad choices as (1) leaving the balance between DB members and employers broadly the same (2) shifting the balance in favor of member security at the possible risk of “significant negative impact” on corporate sponsors and (3) shifting the balance to soften the pension promise, creating “welcome easement” to firms at the expense of reducing the value of pensions paid to members. Beyond that point LCP said they broadly agreed with the response of the ACA (summarised below). LCP believe that small changes (to regulation) are unlikely to have a positive impact:

“We think it unlikely that small changes to the current pension regulatory environment will have a major positive impact, and they may have negative unintended consequences. We strongly recommend that you do not propose changes to Government in order to be “seen to do something” in response to BHS.

LCP also commented that the exit from the European Union might present opportunities to change legislation.


On the issue of regulating the effect on pensions of corporate action, Mercer believed the onus could be moved to the other relevant regulators (such as the FRC, PRA or takeoever panel), to take into account pensions issues in the context of corporate activity, rather than the “single issue” pensions regulator becoming involved in corporate activity. Mercer suggested that advisers themselves could be an enhanced source of regulation by increased use of “whistleblowing” type activity and an enhanced focus on the need for members of professionally regulated bodies to do this.

On the question of TPR’s powers, Mercer made the point that before considering new powers the way TPR exercises it’s current powers should be evaluated, as it is possible the current powers are sufficient, but not being fully utilized. New powers would not necessarily reduce the risks faced by pension schemes. Making TPR more interventionist would not guarantee better outcomes, and might impose additional costs on trustees for no gain.

On the question of whether the current market conditions warranted an exceptional approach:

“Unfortunately, it is not possible to tell if the current environment is exceptional, and so difficult to say it warrants an exceptional approach.

“Our view is that the purpose of a valuation is to impose some controls over the future expected cost of providing the scheme and the pace at which that cost is met. The statutory funding regime achieves that. If a non-market related approach were introduced, the results might be different, but they would also have no context, be virtually meaningless (for example, they might not give appropriate signals to inform investment strategy), and inevitably short lived.

Association of Consulting Actuaries

Made some very similar points to Mercer in the role that other regulators could play with regard to pensions, and much of the wording in other areas also bears a lot of similarity, suggesting there was a lot of common input.

In particular the ACA highlighted a possible role for other regulators:

“Consider the role of all regulators that could possibly have authority over actions that might affect pension scheme outcomes, and how they could use their powers to influence good governance in relation to decisions and advice affecting workplace pension provision.

Gave examples of the Takeover Panel, PRA and FRC, noting that the TPR itself does not regulate the way companies are run, and how they balance the demands of DB pension provision against other things.

“…corporate responsibility for balancing the security of company pension schemes with their other priorities seems a matter for other regulators, such as the FRC or PRA, with responsibility for good corporate management and governance.

Believe making TPR more interventionist, from it’s current supervisory and guidance stance is not a guarantee of better outcomes, not helped by the TPR’s internally inconsistent and conflicting objectives.

On the TPR’s powers the ACA response (again similarly to Mercer) emphasis the belief that existing powers have perhaps been underused or in practice are “illusory”

TPR has seldom used those of its powers that would directly impact company decisions, which has perhaps led many to view that its powers are illusory (for example, because the hurdles to cross before they can be used are too onerous). It is possible that the threat of using them has always proved sufficient, but that is not obvious to many in the industry. TPR has to produce reports about when it does use its powers; some clarification around situations where it chooses not to might also be helpful.

The ACA noted that TPR’s objective to minimize claims against the PPF skews it’s focus (towards larger schemes, even if they are at lower risk of default) in a way that is not necessarily optimal for the functioning of the system as a whole.

The ACA suggest a statutory override to RPI benefits (moving them to CPI) in the context of generating inter-generationally fair outcomes in relation to money purchase pension recipients. ACA note that the intention of trust law probably wasn’t to hardwire benefit increases to a particular index and also that mandatory indexation was enshrined by the Pensions Act 1995, suggesting that it is appropriate for the government to legislate to overcome problems created by previous legislation.

Mentions consolidation relatively briefly, makes the point that benefit complexity is one barrier to this happening, suggests that introduction of a facility whereby historic benefits can be converted to a single standard would facilitate this.


Aon believe that the inquiry into DB should be considered in the context of DC – money spent on DB  can’t be spent on DC. Aon believe that an intermediate solution should be available to some schemes between full benefits and PPF levels. Focusing more on bigger regulatory changes rather than tweaks AON made some quite developed suggestions in regard to intermediate solutions, for workable changes to the existing regime. Broadly these suggetions were in favor of an intermediate benefit solution based on conditional indexation and moving to more of a “with-profits” style system with  regard to pension increases (pay increases conditional on the performance of growth assets). Aon suggested that a change to a with-profits system (including within the PPF) might make it easier to push for consolidation of schemes without subsidy.

Of the consulting firms Aon came closest to advocating changes to the funding approach- articulating the benefits of a cashflow and probability of success measurement regime as opposed to a present value and funding level, however overall Aon reflected a balanced view here, arguing for a “wider range” of approaches, including both present value and cashflow approaches, rather than a replacement of the present value approach.

“A present value approach is not wrong. It encapsulates the valuation in a single figure, which probably does reflect where the scheme is trying to get to in the long-term. It also tends to encourage more immediate action in response to changing circumstances, although this means reducing deficit contributions when deficits reduce, as well as increasing deficit contributions when deficits increase. However, the present value approach does have a number of disadvantages which are becoming more apparent in the current low yielding and volatile environment

Aon suggest giving company directors a responsibility to consider the funding level of the pension scheme when deciding upon dividends.

AON “called out” the practical challenges associated with consolidation – namely that it’s tricky to do it in a way that both avoids cross-subsidies between schemes AND achieves the enhanced governance objectives of consolidation. This is important as the concept of consolidation seems an easy one to agree upon, but much harder to find workable ways to achieve it in reality.


Cardano believe that the regime should be changed to engender (1) greater prevention – by focusing on the economic value of the liabilites (rather than the technical provisions basis which allows for asset returns) and (2) more flexibility – with the ability for trustees to negotiate with employer to get to an intermediate solution between full benefits and PPF benefits, in advance of a full corporate insolvency process. Cardano believe that there is a systemic affordability issue that government needs to address.  Cardano believe that the current system of Technical Provisions gives a false sense of security, they also referred to the increased cashflow negativity of schemes and path dependency issues this creates as schemes pay out full benefits while being substantially underfunded on a full economic basis.

Cardano are critical of the Technical Provisions as a measure of scheme health and believe this has not fostered the best decision making:

“The recovery plans, approved by The Pensions Regulator (TPR), have also been sliding. As schemes have become more severely underfunded, longer recovery periods and higher future return expectations have been accepted. So a fuzzy measure of the health of the pension fund (Technical Provisions) contributed to poor risk management on behalf of trustees, which led to deteriorating funding positions, and that has been met, broadly, by TPR simply relaxing the parameters, and tacitly accepting the new status quo.


What are the key questions that divide the respondents?

I think you can boil it down to the following subjective questions with the above respondents divided on pretty much all of these points

  1. Is large-scale reform of the DB system needed (to generate better and more optimal outcomes for members and sponsors)
  2. Are small-scale tweaks to existing regulations worth considering
  3. Should an intermediate solution between full benefits and PPF levels be investigated
  4. Should there be consolidation among schemes
  5. Would additional interventionist powers in TPR be overall helpful to pension security

What common themes were there among the responses?

I think there was broad agreement on what the key challenges are – namely balancing security for members with sustainability for employers. This question seems to frame the debate at the right level for government consideration, rather than getting too absorbed in the particular details.

I think there was general agreement that changes to the funding regime, particularly moving the basis on which the liabilities away from one which references bond yields are not warranted.

Scheme consolidation and conditional benefit indexation were two frequently occurring suggestions that while not universally agreed upon, would appear in my view to have enough advocates for further investigation.

A considerable number of suggestions were made regarding smaller incremental improvements to current legislation, although there was disagreement on the question of whether incremental improvements is in itself worthwhile or beneficial or wholesale reform needed. Again that question seems framed at the right level for government consideration.

There seemed to be agreement that the current system is not set up to deliver inter-generationally fair outcomes, given that younger employees (particularly in the private sector) have no access to DB provision and are likely to receive lower pensions in relative terms than previous generations. There were several suggestions that the DB reforms should be considered in the context of/alongside the DC system in the knowledge that imposing increased costs on the DB side will impact DC.

So there you have my take on the consulting community responses to the WPSC BHS pensions inquiry. Do let me know your thoughts.

Grim Summer for DB Pensions

It’s not been a good summer for the financial health of UK DB pension funds.

Data released by the PPF in September underlined a summer of bad news for schemes and scheme sponsors.

A continued trend of falling gilt yields have seen liability values increase dramatically – adding more than £200bn to the aggregate deficit compared to the start of the year. The aggregate funding level (on the PPF basis) fell to 76% at the end of August, the lowest value in the 10-year history of the series. For context the funding level on this basis was close to 100% at the end of 2013.

Long-dated gilt yields have fallen from around 2.5% at the start of the year to around 1.2% by the end of August.

The result of the referendum vote certainly added impetus to the move lower in gilt yields, as “lower for longer” became a more likely scenario, and this was re-enforced by the BoE’s announcement of renewed bond purchases (quantitative easing) and a cut in interest rates to 0.25%.

While asset markets have generally performed positively – especially overseas equities in £ terms, these good results have been insufficient to keep pace with unhedged liabilities.

It seems likely that actuarial valuations as at 30 June or 30 September are likely to contain bad news for corporate sponsors, prompting tough conversations such as those happening at plastics manufacturer Carclo, and negative headlines such as those at Associated British Foods. These are likely to become more and more common as we move forward, as highlighted by LCP in their Accounting for Pensions report.



Taming Pension Risk? 

This article first appeared in the May 2016 edition of The Actuary magazine (here)

The past 10 years have been a uniquely challenging, volatile and uncertain period for UK defined benefit pension schemes. How well have they weathered the storm? We found out by analysing data published by the Pension Protection Fund (PPF) in its annual Pensions Universe Risk Profile or ‘Purple Book’, plus other industry-wide data from leading sources.
The asset side of the story, viewed in isolation, seems positive. Total assets have grown from £770bn in 2006 to £1,254bn in 2015, an average increase of around 5% per year, albeit a very significant proportion, possibly 25-45% of the increase, has come from contributions. Over a period that includes several crises, the asset value has had a relatively low volatility (or standard deviation) of about 5% per year.
Total liabilities have grown even faster though, at an average rate of around 7% per year. The increase is from £790bn in 2006 to £1,516bn in 2015 on the PPF’s measure (which, for most schemes, caps benefits and pension increases), or from around £1trn to just under £2trn based on full benefits.

Furthermore, the volatility has been about 14% per year, almost three times that of the assets – largely a consequence of plunging yields on British government bonds or ‘gilts’, which are used as a benchmark for valuing the liabilities.
Asset allocation has changed in two main respects. Firstly, there has been a move away from equities – from 61% in 2006 to 33% in 2015 (see Figure 1 below) – in particular, a reduction

in UK equities. A slightly different dataset published by UBS shows allocations to equities of over 80% in the 1990s, so the past decade is part of a continuing trend.
As discussed later, this has reduced the level of risk, but it has also reduced the expected future investment returns in excess of the liabilities, by around one-third over the decade. The second trend is an increase in the amount of liability hedging.

When long dated interest rates fall or inflation rises, the value of liabilities increases relative to the assets. This can be hedged by investing in matching bonds, but also by entering into derivative transactions with similar economic properties to bonds.
From a risk perspective, the key statistic is the hedge ratio, which estimates the proportion of liabilities that are effectively hedged (or immunised) against movements in interest rates or inflation. Using data published by KPMG in its annual Liability Driven Investment (LDI) Survey, we estimate that the average hedge ratio has increased over the past 10 years from 15% to around 33%.
At an aggregate level, there have been small second-order changes in asset allocation relating to a greater use of hedge funds and other assets, albeit a more pronounced feature in some individual schemes, and fluctuating levels of cash. Holdings in property of around 5% in aggregate are a fairly constant feature.

Risk change – a conflicting story

To gain insight into the de-risking effect of these asset allocation changes, we ran the data through our pension risk model. Figure 2 (below) measures risk in relative terms, showing the possible change in funding ratio of assets to liabilities at a given confidence level, often called funding ratio at risk (FRaR) and measured in percentage terms, which is useful to trustees in quantifying how benefit coverage could be affected in an adverse period.
In 2006/07, pension schemes were running an average FRaR of 20%, meaning they had a

one in 20 probability of suffering a funding ratio fall of 20% or more over one year.
As expected, it can be seen that the asset allocation changes implied by the aggregate data (a reduction in equities and an increase in liability hedging) have been risk-reducing, with the FRaR having decreased to about 10% by 2015.
These risk levels may seem large, but, to put them into perspective, over the decade funding levels have twice fallen by more than 20% in a one-year period (according to the PPF’s data) – once in the year to April 2009 at the lows of the financial crisis, and once in the year to May 2012 as bond yields fell.
Figure 3 (below) measures risk in another way, in absolute monetary terms, showing the possible change in funding deficit or surplus at a given confidence level, often referred to as value at risk or VaR.

This is often helpful to corporate sponsors in indicating how much the pension scheme could affect their balance sheets.
In 2006, the aggregate VaR was around £300bn, meaning they had a one in 20 probability of suffering a combined increase in funding deficit of £300bn or more over one year (this is based on full benefits rather than the lower PPF measure).
While the VaR is influenced by similar factors to the FRaR, it is also affected by the size of the pension schemes. The overall increase in size of the assets and liabilities overwhelms the de-risking described earlier, resulting in an increase in VaR to £450bn in 2015. Again, putting these figures into perspective, there was one annual period (the year to May 2012) where the combined deficit increased by more than £300bn.

Efficient risk reduction

Will the current asset allocation deliver the returns that pension schemes need to be fully funded? We cannot tell from the aggregate data, as each individual pension scheme has its own specific circumstances, such as funding and investment strategy. We can say that, on average, while funding ratio risks are lower today than in 2006, so are the expected future investment returns.

Many pension schemes want to continue to reduce risk. After all, the risk to the funding ratio described earlier, of 10% over one year, is still substantial in the eyes of the majority of schemes and corporate sponsors. However, they need to generate the same, or increased, investment returns to close their deficits over the next 15 or 20 years.

The solution is to stop viewing investments in terms of fixed buckets of ‘growth’ or ‘matching’ assets and embrace modern-day liability management techniques. This includes the use of derivatives to reduce liability-related risks without needing to invest the majority of the portfolio in bonds, thereby enabling the scheme to invest the remainder in a range of return-seeking assets.

Using the principles of diversification, risk control and downside protection, schemes can generate returns more efficiently – that is, for less risk – than has been achieved previously.

Dan Mikulskis is managing director and co-head of asset liability management and investment strategy at Redington Ltd

– See more at: http://www.theactuary.com/features/2016/05/taming-pension-risk/#.dpuf



Pension Funding Levels Plunge in January 2016

The first 2016 update of the PPF index (of UK defined benefit pension funds) is just out, and it wasn’t pretty

Falling long-dated interest rates over the month (the 30 year gilt rate fell by 0.3% to 2.3%) caused the present value of the liabilities to increase by some 6%, while the assets were virtually unchanged (presumably some positive returns from bonds being offset by negative returns from equities).

Overall this caused a fall in the aggregate funding level of 4.4%. This reverses the gains made in the 4th quarter of 2015. Only twice in the 10-year history has the funding level been lower – in January last year and in May of 2012 when the funding level fell below 80%.

Worth noting is that the funding ratio tracked here is in respect of the PPF-liabilities, which are usually less than the standard contractual liabilities of the scheme. Typically the self-sufficiency liability valuations that scheme trustees might use would be 25% higher.

The total deficit increased by nearly 80bn to the second-highest on record at 304bn.

I estimate that this increase in deficit would add roughly 0.4-0.5% p.a. to the returns required every year to become fully funded over the next 15 or 20 years (which might not sound like a lot, but given the difficulty and risk associated with achieving the already high returns many schemes need this can be quite challenging). Put another way, this extends the time to full funding for a scheme which resembles this average position by around 3 years.

The variation in the overall funding position remains driven by the liabilities, which have had a volatility nearly three times that of the assets over the life of the data series, pointing toward LDI strategies as the first port-of-call for pension schemes trying to stabilize their funding position.

In a paper written last year I commented on the asset allocation changes in UK pension schemes. There has been some adoption of LDI strategies, but much de-risking has consisted of removing return seeking assets without fully hedging LDI risks, which leaves schemes vulnerable to interest rates falling a we have seen this month.

PPF Jan 2016


Mind the gap – funding levels fall as market volatility hits assets

The PPF today published its monthly estimates of scheme funding position for the schemes in the PPF 7800 index.

Not surprisingly, given the market moves over September 2015, and over the third quarter generally we saw a 5% decline in funded status over the quarter due to both declining asset values and increasing liabilities.

It’s been a bumpy ride for pension schemes over the last year as the liability side of pension scheme balance sheets have been impacted by volatile and falling gilt yields, while the asset side has now been hit by the equity market volatility we’ve seen through August and September.

Both the funding position (79.9%) and deficit (at £311.7bn) are close to the January 2015 positions, which were the worst in the 10-year history of the dataset.

PPF (12)

What does this mean for most pension funds?

The major impact this will have on a pension fund will be the Required Return they need to become fully funded over the target investment horizon of the scheme (which will vary).

Roughly speaking a 5% worsening in funding level might equate to a 0.5% per annum increase in required return over, say, a 15 year investment horizon. It would mean a significantly higher increase in required return over a short time horizon of 10 years or less (see figure 1)

If the expected returns from the assets are held constant then a 5% fall in funding level would push the full funding date out by around 5 years (see figure 3).

Figure 1: Required returns to different full funding dates
Figure 2: quarterly funding level changes of PPF 7800 index
figure 3: Projected scheme full funding dates for various starting funding levels & future excess returns
figure 3: Projected scheme full funding dates for various starting funding levels & future excess returns

Following these falls, what should pension schemes do? 

  • Revisit their funding goals, and ask whether these are still achievable;
  • Check the investment strategy is on track to meet the returns they need;
  • Avoid knee-jerk reactions by sticking to a decision making framework.

What Can Pension Schemes Learn from the PPF ?

The PPF publishes regular updates on the financial health of DB pension schemes in the UK (the PPF 7800 index) and also its own funding position.

In recent times there has been quite some contrast between the two sets of figures (thanks to Pensions Expert for a great article highlighting this.

Piktochart PPF vs Everyone (2)

Sure, the PPF collects a levy (from schemes) whereas individual schemes have varying levels of sponsor support and contribution, however the biggest factor in the contrasting fortunes is the investment strategy.

Perhaps the PPF, as a c£20bn investor simply has access to strategies and tools that are hopelessly beyond most pension schemes? In some cases this is true, but taking a look at the really key drivers of the PPF’s recent success, this isn’t really the case.

In the statement, Andy McKinnon, chief financial officer at the PPF, said: “The greatest impact on our financial position has been the increase in the value of our liabilities caused by falling interest rates…

“The matching effect of our investment programme has acted to mitigate this and contributed a further £1bn to the surplus.”

Liability matching techniques are available to pretty much any pension scheme (the advent of pooled LDI has made available very effective solutions even to the smallest schemes). It’s just that the PPF have adopted these techniques with great success, the track record being clear to see.

With interest rate risk having such a large bearing on most pension funds, pension schemes have the option to play a continued game of Snakes & Ladders as rates rise and fall, or to do as the PPF have and close down these risks, instead taking measured amounts of risk in other areas.

The track records of the two results are pretty clear.