Woolly's blog

Between a rock and a hard place

Published by Matthew Furniss, 7 Oct 2011

The highly anticipated move by the Bank of England to implement another tranche of quantitative easing (QE) is providing exactly the circumstances of higher deficits for pension schemes I referred to in my previous blog Twist or Stick, albeit for a different reason. This is a stark reminder that there are multiple ways in which policy or economic changes and shocks can impact schemes.

The key difference between Operation Twist and QE is that the latter is putting more money into the economy rather than re-allocating money.  This brings the risk of further inflation back into the picture although this is certainly debatable.  The Bank of England's view is that inflation is expected to drop off significantly going forward (before QE was implemented), but then actual inflation has been above the central bank's target for over 60 months now so the credibility of this has to be questioned.

It goes without saying that low gilt yields (particularly long dated yields) combined with higher inflation expectations equals bad news for pension schemes in terms of deficits.  But then the alternative of depressed growth in the economy means a reduction in the covenant behind the nation's pension schemes and the likelihood of schemes' assets returns remaining subdued.

So schemes are somewhat stuck between a rock and a hard place.  Policy decisions are obviously driven by the economy as a whole and pension scheme pain can often be a price worth paying.

Woolly goes walkabout

Published by Woolly, 30 Sep 2011

I am now back on the Fells after a hectic week at the Professional Pensions Show. Leaving aside the two young ladies who tried to sheep-nap me and some bounder who questioned my pedigree, it was very good to meet so many of my followers.

And talking of following, it was encouraging that so many of the attendees followed my hoof prints to the PensionsFirst stand to hear more about the revolution in measuring and managing risk that I bleat about on these pages. Thank you too to those of you that took part in the PensionsFirst survey with the chance to win tickets to the Olympics - for those that missed out here's another chance to take part.

It was encouraging to hear Chief Executive of the Pension Protection Fund (PPF), Alan Rubenstein, announce that the pension protection levy estimate for 2012/13 would be set at a record low of £550m.  However, this may provide little consolation for UK pension schemes that have seen tens of billions added to funding deficits over recent weeks.

Overall I thought the show a resounding success and particularly enjoyed the chance to listen to Steve Webb and Bill Galvin.  So a big pat on the fleece for the folks at Professional Pensions and I am already looking forward to my next outing at the NAPF show.

Incentivising pension savings

Published by Woolly, 29 Sep 2011

Did you see the article in the Daily Express yesterday about the 2 million people that expect to have to cash in the equity in their home to fund their retirement Alarm over the 2million cashing in their homes to fund pensions This brings me back to an old hobby-horse of mine. If the Government is willing to give us tax breaks to incentivise us to fund our pensions, why, oh why can we not hold our primary residence as a pension scheme asset?

Most of us feel much more comfortable owning residential property, which is broadly inflation linked and has a real utility value, than investing in volatile financial assets that few of us understand. If we could use our pension savings to purchase our homes, all we would need is for the mortgage industry to come up with an equitable equity release product and we would have a perfect pension asset, with a real incentive to save for retirement. We have one of the highest levels of home ownership in the world and yet instead of encouraging us to link this to funding of our retirement needs, the Government incentivises us to bet our retirement savings in the financial markets, about which many are at best sceptical and at worst bearish. Admissibility of our homes as a pensions asset would also provide a strong underpin to the residential property market in troubled economic times, with a strong positive impact on consumer confidence. So it seems to me that other than loss of revenue to investment managers, there is only upside in this proposal.

Categories: News, Equities, Assets

A horror story for pension schemes

Published by Andrew Morris, 26 Sep 2011

The last month has seen some horrific drops in investment markets with last Thursday being a notable example - nearly 5% was wiped off the FTSE 100 index in one single day. This news must terrify trustees and scheme members alike however, looking at investment markets or headline news in isolation rarely tells the full story. Over September, UK equities have tumbled around 6% however, these falls have been offset somewhat by increases in other asset classes such as corporate bonds and gilts. As dreadful as last Thursday may have seemed, the pension assets held by the FTSE 100 pension schemes are likely to have been down by as little as 2% in aggregate depending on the precise asset mix your scheme is holding.

So, should anyone really be that scared? As I often comment, it is important to consider all of the risks that affect a pension scheme and September has indeed been a remarkable month. Looking at the liabilities of the FTSE 100 pension schemes it is likely that accounting liabilities have increased by almost as much as assets have dropped and funding liabilities are likely to have increased by more than this. This news is often missed with movements in liabilities regularly outweighing changes in asset portfolios. What worries me is that managing pension risk is as much about understanding the liabilities of the scheme as it is the assets - a concern that too often falls on deaf ears.

The impact on funding deficits over September has been close to a 1-in-20 event - equivalent to an increase in accounting deficit of close to 60%. Most risk managers would consider this significant, but I expect that many pension schemes are unaware of the actual impact on the funding level. In the current environment, very few trustee groups or sponsors actually have access to the timely reporting they require to understand events such as these. As horrific as falls in asset values might be, the real horror story is that there is little chance of ever mitigating or understanding these risks until appropriate reporting is in place.

Categories: Covenant, Risk, Deficit, Reporting

Twist or stick?

Published by Matthew Furniss, 26 Sep 2011

Across the pond, a new growth initiative known as “Operation Twist” is underway. In simple terms the Fed is selling short-dated bonds to buy long-dated bonds – the aim being to reduce long-term interest rates, stimulate medium to long-term investment decisions and hence promote short-term growth. In theory, this seems reasonable. Whether it will work is anyone’s guess.

This is certainly thought provoking material for UK pension schemes.  At first glance, it might be considered that this is of little significance in the UK.  Changes in demand and supply for US long-term debt will have some second order impacts on the UK bond market but probably not to the extent that this will drive too much UK pension fund activity.

The more interesting questions to ask are how likely is this policy move in the UK, what impact would this have on pension deficits, and what should schemes be doing about it?

On the first point, it's difficult to write off the possibility.  Growth has become both the key financial and political risk, and stimulus methods are fast running out with interest rates are at an all time low, and increasing debt further unpalatable.  Why wouldn't the Bank of England try 'Twisting'?

The impact of such a move is difficult to quantify.  When this was last attempted in the US in the 1960s, long-term rates only fell by up to 0.2% p.a. and this was seen as a disappointing outcome.  However, even a small change like this could increase pension liabilities by several percent, although this might be offset to a degree if a scheme held some longer term bonds.  Of course, the greater the success of 'Twisting' the worse it is likely to be for schemes' deficits.

So what should schemes be doing?  I think it's worth careful consideration.  For example, many schemes have dismissed interest rate swaps at this time with rates so low.  Reviewing these types of decisions would be a sensible first step.

Overall, I'd want to know what would be the impact on my scheme, how does this risk fit in comparison to my other risks, and does my scheme have the governance procedures in place to protect against the impact of such a policy decision.  What would your scheme do - stick or twist?

Business as usual?

Published by Matthew Furniss, 19 Sep 2011

I entirely agree with Capita Fiduciary Group’s view that sponsors should treat pension schemes as a subsidiary of their business because of the impact schemes have on companies.

Pension scheme deficits are clearly pivotal to the success or failure of some companies but schemes have historically been viewed as slow moving, long term entities and analysed as such.  Things have changed though. Today's volatile economic times mean that companies really need to get to grips with the nature of their deficits to the standards that they do with other risks their business faces. 

Capita's research notes that nearly three-quarters of FDs discussed their pension scheme at less than half of their board meetings.  Capita find these results surprising  -  I'm not sure I do!  From my conversations with FDs there is frustration that, although there is a desire to have informed conversations around schemes and strategy, this has proven difficult on a regular basis due to the quality of analytics available.

This means FDs are beginning to demand funding and risk pension numbers that they can trust with confidence within a period where they are still relevant.  If you don't believe numbers put in front of you, you're not going to act on them!

A perfect storm during summer?

Published by Andrew Morris, 9 Aug 2011

As many are returning from or getting ready to enjoy their summer holiday, the DB pensions industry has been experiencing what many would consider to be a perfect storm. In the last week or so we have witnessed painful daily drops in asset values. However, focussing just on assets misses half of the story. Unfortunately, changes in the value of DB liabilities have been of the same order as asset movements - and to the detriment of the funding position.

The true extent of the damage to funding levels is yet to emerge - as it is not clear whether this is a temporary blip or longer term impact on funding levels. What is clear is that the last few months represented a good opportunity to take some risk off of the table - certainly when you compare to today's funding level. So, what has actually happened to pension scheme funding levels recently? Comparing to one month ago, the accounting deficit of UK pension schemes has increased 3-fold - representing a 10% drop in funding levels. The driving factors behind this have affected all liability bases - not only has the accounting position deteriorated but the cost of buyout has increased as well.

So, how does a pension scheme weather this storm? Well, there are a great number of things that can be done - and the next few weeks or months will present opportunities through the relative movements of assets and liabilities. Having the tools in-place to monitor the current position accurately is the best way to ensure opportunities are appropriately considered as and when they present themselves.

The last few months have shown that opportunities don't always exist for long. In this age of volatility, opportunities to de-risk come and go. The wise may have limited some of the slide in funding level by de-risking when equity markets were at a high. The really wise are already prepared for the next opportunity.

Categories: News

Make hay while the sun shines...

Published by Woolly, 26 Jul 2011

Regular readers of my posts will know that I am a huge advocate of pension schemes managing risk away from the corporate balance sheet, so it was with great joy that, while hoofing through the weekend’s financial papers, I stumbled across an article in the FT declaring an “unprecedented” growth in interest in pension buy-ins. It is not hard to see why – favourable markets and falling deficits mean that the sun is shining on pension schemes right now.

However, growing up on the fells, I quickly learnt that the sun never lasts. And pension schemes face similarly volatile conditions. Cast your mind back to 2008, when there was also value to be had in the risk-transfer market and schemes enjoyed favourable funding positions - the majority were looking forward to good times ahead. For most the opportunity was lost as the financial crisis hit and they slipped back into deficit.

The cloud on the horizon this time comes in the form of the introduction of Solvency II which, from the start of 2014, will increase insurers' capital requirements and make it less attractive for them to take on pensions liabilities. KPMG reports that this could see schemes being forced to pay a substantially greater premium to remove risk. It would seem the smart move, therefore, is to act now.

Yet while well-prepared schemes are now taking the opportunity to take risk off the table, many will  miss the opportunity because they continue to rely on a triennial valuation of their liabilities to manage risk. While this information may be updated for scheme and economic changes in the interim, such approximations are unsuitable for decision-making purposes - that's when opportunities are missed.  Fortunately for an increasing number the pensions industry has moved on since 2008 and the more enlightened are now using technology to help them measure and manage risk in real time - there is no excuse for making the same mistake twice.

For further information on this topic please see PensionsFirst's white-paper Insurance-based solutions: timing is everything.

Categories: News, Risk, Buy-ins, Technology

Does an actuarial valuation have to cost so much?

Published by Andrew Morris, 5 Jul 2011

If being "reassuringly expensive" doesn't fill you with confidence, then read on! A traditional actuarial valuation takes a long time to produce and involves a great number of professionals however, it's really the amount of time between valuations and the lack of a single valuation platform that pushes the price up.

Exploring the process an actuarial consultancy applies when it comes to a triennial valuation reveals that quite often there is very little continuity from one valuation to the next. The junior actuaries and analysts that worked on the previous valuation have often moved to different positions externally or internally three years later. So, the fee for a valuation may include a training aspect and time for new team members to get up to speed.

Further to this, there are cost implications of taking your eye off the ball. Tracking all of the membership movements and trying to explain all of the changes to the scheme in one valuation means the process can be incredibly long winded, complicated and therefore expensive.

Is there a more cost effective alternative? I think there is - by utilising modern technology it is possible to run more regular valuations and avoid the large one off costs that occur every three years. Regular valuations also allow movements and changes to be captured and understood as and when they occur rather than having nasty surprises lurking every three years.

Finally, often the most expensive aspect of a triennial valuation is the negotiation around assumptions. The cost of having two sets of actuaries (one advising the trustee and one advising the sponsor) each running valuations or performing estimates can increase the cost of a valuation significantly. Having one platform that can be used by both sets of actuaries with the same level of accuracy would certainly help keep valuation costs to a minimum - merely by avoiding replication.

Categories: Valuation, Liabilities, Technology

World Class

Published by Woolly, 1 Jul 2011

As you all know, as a sheep I am cautious about attending public events, but I heard from my pensions industry buddies that PensionsFirst took home its second consecutive award for Pensions Technology Provider of the Year at the European Pensions Awards last night.

Congratulations to the entire PensionsFirst team for another year of incredible work. Your efforts have made PensionsFirst a leader in the field of pensions technology and this recognition is a reflection of your talent and significant contribution to the defined benefit pensions industry. I also want to extend my congratulations to the staff at European Pensions and the awards' jurors and sponsors for making this year's event an unqualified success.

These back-to-back award wins by PensionsFirst highlight an on-going trend in the industry towards the use of technology to help measure and manage funding and risk. Certainly, the issues they help tackle will remain current, so I expect a few shearing seasons from now, PensionsFirst will still be picking up awards for their innovative technology.

Categories: Awards, Technology