By Dale Walmsley, Partner at First Actuarial
What’s going on with defined benefit pension schemes?
The UK Government’s mini budget in late September caused unprecedented volatility in the government bond (gilt) market. Between the start of Monday 26 September and end of Tuesday 27 September, gilt values tumbled and the yield increased by around 0.85% pa.
Higher gilt yields are generally good news for pension schemes, as a higher yield means that a lower value is placed on a scheme’s liabilities and the cost of future pension build-up. However, many schemes invest in liability-driven investment (LDI). This kind of investment often uses leverage to get more liability matching from a smaller proportion of a scheme’s assets. This frees up other assets to generate growth (or, in non-technical terms, ‘more bang for your buck’).
Suggestions in the media that schemes were close to insolvency were wide of the mark. What some defined benefit (DB) schemes did face was a liquidity problem – collateral requirements from LDI managers meant schemes had to find cash to top up funds or risk losing some of their interest and inflation protection.
The Bank of England stepped in on 28 September to prevent a fire sale of assets to meet those collateral calls. Of particular concern to the bank was that some of the assets being sold to make collateral payments were gilts. This pushed the price of gilts down further. As a result, LDI funds needed more collateral. Some of the assets sold to make those collateral payments were gilts. This pushed the price – you get the idea.
Now the dust has settled, many DB schemes have seen their liabilities fall by more than their assets – and are considering how to react to improved funding positions.
The cost of new DB benefits
One area that has gone largely unreported is the positive impact this has had on the cost of future benefit build-up in DB schemes. On the chart below, I have plotted an estimate of how the total cost of providing a pension in a career average revalued earnings (CARE) 1/80ths scheme has changed in recent years.
The reduction in cost over the last year – the last couple of months in particular – is clear.
How are the sector’s schemes responding?
Scottish Housing Associations’ Pension Scheme
The Employer Committee (EC) has recently confirmed that future service contributions will remain at their current rate until at least 1 April 2024.
For example, the cost of the CARE 1/80ths section will remain at 23.7% of pensionable pay (which, looking at my graph above, still looks quite prudent in current market conditions).
This is a sensible and pragmatic decision in my view and will give employers an element of certainty as market conditions hopefully settle over the next year or so.
Action: Finance teams can now finalise pension costs in their budget projections using the current future service contributions rates.
The EC has also re-opened its consultation into two potential benefit changes, and has requested views from employers on the proposals (more information can be found in my recent SFHA blog post).
In my view, despite the recent fall in the cost of the funding new DB benefits, the changes being proposed are a sensible way to make the DB sections more sustainable.
Action: Employers with employees still earning benefits in the DB section should respond to the consultation by Friday 3 February 2023.
Local Government Pension Scheme (LGPS Scotland)
The next actuarial valuation of the various LGPS funds in Scotland has an effective date of 31 March 2023, with changes in contributions due to come into effect from 1 April 2024.
Since the previous valuation:
All things being equal, I would expect to see a reduction in employer contributions from April 2024, as well as a significant reduction in cessation debts over the same period. Indeed, some cessation positions may now have turned to surplus.
Action: Organisations looking to exit the LGPS, or those monitoring a decreasing active membership, should consider whether now is an affordable time to trigger cessation.
Single employer schemes
For employers with their own DB scheme (as opposed to participation in a multi-employer scheme), the impact of the last few months on that scheme’s funding levels will depend on:
Some schemes will have seen material improvements in their funding levels, while well hedged schemes using LDI may have seen a material reduction.
Action: Organisations should request a funding update from the trustees and consider whether any de-risking opportunities are available if the funding level has improved.
Should you review your pensions governance?
The recent headlines have highlighted the importance of having a governance process in place to monitor and act on changes to pension costs, risks and current issues. If you would like to discuss what we think best practice scheme governance looks like, please get in touch.
Dale Walmsley
Partner
dale.walmsley@firstactuarial.co.uk