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
#DBDeficits

Lawrence Churchill
Chair
Pensions Policy Institute
#DBDeficits

Jennifer Donohue
Partner
Ince & Co LLP
#DBDeficits

Discussion and Q&A
#DBDeficits

Close
Baroness Sally Greengross
Chief Executive
ILC-UK
#DBDeficits

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

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