With the second round of the defined benefit (DB) funding code consultation closing at the end of March, pension schemes, industry groups and consultants are calling on policymakers to push back on implementing new funding rules until next year, citing a greater need to distinguish between open and closed schemes.
Among the critics is USS, Britain’s largest open DB pension scheme, which in a rare sign of unity sent an open letter jointly signed by USS CEO Bill Galvin (pictured) UCU general secretary Jo Grady and Stuart McLean, director of Pensions at Universities UK.
They urged The Pensions Regulator (TPR) and the government to establish greater awareness of the unique nature of open DB schemes, particularly multi-employer schemes. USS said that open schemes should not be “forced into an unnecessary de-risking journey” and suggested that funding rules for open schemes should be covered in a separate chapter of the code.
The PLSA backed calls to push back implementing the new funding rules until April 2024, on the grounds that “a disconnect between TPR’s interpretations in the code and the requirements in the regulations which, in their current form, are more prescriptive in a number of areas”.
This included among others concerns about the requirement to invest in a so called “low dependence” strategy.
“It is important to point out that not all DB schemes are the same or are at the same stage in their journey to maturity,” the PLSA’s response said, warning that open DB schemes need greater flexibility in their investment strategies.
Unfortunate timing
The Department for Work and Pensions (DWP) launched the second consultation in July, with the aim of setting the rules on DB funding based on the 2021 Pension Schemes Act. The proposals included a requirement of “low dependency” for mature DB schemes, which effectively meant a transition to presumably lower risk fixed income assets. At the time, critics pointed out that this would effectively pressurise schemes to adopt a liability-driven investing (LDI) approach.
The consultation was meant to close in October but was overtaken by events – the autumn of 2022 turned out to be a spectacularly bad time to promote the low-risk nature of fixed income.
Recognising the dramatic impact of last year’s gilt crisis on DB schemes, the DWP and TPR agreed to push back the consultation until the end of March 2023, with the aim of implementing the new funding rules from October.
Open wounds
But seven months and two pensions ministers on from the mini-budget, much still remains to be clarified. DB schemes are still nursing considerable losses. At first glance, they were sitting on a considerable surplus of almost £400bn in February, according to the Pension Protection Fund (PPF). But that was almost entirely due to the fall in liabilities as a result of rising gilt yields. On the asset side, the impact of the bond market meltdown has been devastating for LDI strategies, data by the Office for National Statistics (ONS) shows.
The market value of private sector DB and hybrid schemes fell by 12% between June and September last year, a drop to £1.28trn from £1.45trn, the ONS said. Throughout the same period, the value of defined contribution and public sector DB hybrid schemes fell by only 1%.
The ONS is clear on the culprit: “Greater exposure to rising gilt yields, including through liability driven investment, explains the larger percentage fall in private sector DB hybrid pension schemes’ market value over quarter 2 and quarter 3, 2022.”
But despite these dramatic losses, DB schemes did not sell their gilts for two obvious reasons: rising yields and the increased maturity of schemes. The combination of these factors accelerated the push for endgame strategies, including demand for buyouts.
The DB universe shrank to 5,131 from 5,220 last year. More than half are now closed to new benefit accrual, according to the PPF. Lane Clark & Peacock, a consultancy, predicts that this will accelerate the de-risking trend, breaking the £44bn record set in 2019. Phoenix Group forecasts that bulk annuity deals could hit £60bn this year.
In asset allocation terms, demand for fixed income remains persistent, with more than 70% of DB schemes exposed at the end of last year. If anything, demand for cash has increased by nearly 40% throughout the crisis, ONS data showed.
Powerful allies
But open DB schemes are resisting the push towards de-risking. Schemes such as USS now argue that it is not in their interest to prematurely switch to fixed income assets. USS, which manages more than £90bn, is mostly invested in growth assets.
Their call for greater flexibility on asset allocation might be music to the ears of some powerful allies. The treasury and fund managers have been pushing for pensions to allocate more of their assets to UK equities and infrastructure.
While the merits of this strategy remain hotly contested, that, and the damages of last year’s LDI crisis, could play into calls to rethink the DB funding code.
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