In March, 16 of the City of London’s finest minds traipsed to Duke’s Hotel in Mayfair for dinner with UK security minister Tom Tugendhat. The topic of conversation was not Russia sanctions or the world’s growing cyber risks, but pensions.
Tugendhat has form when it comes to campaigning for pension reform — he once accused then prime minister David Cameron of failing to tackle schemes’ large hidden fees. On this occasion, he was focused on another topic, teaming up with his friend Michael Tory, a financier at boutique adviser Ondra Partners. They argue the pensions industry could be made more efficient — and more productive — if schemes were merged and encouraged to invest more in the UK, particularly in equities.
By last week, the idea had been distilled, via the Tony Blair Institute, into a concrete proposal for the UK’s Pension Protection Fund, a lifeboat for defined benefit (DB) schemes, which promise payouts to members in retirement based on member salaries while in work. TBI proposes that the PPF should become more than a giant repository for schemes that have been left stranded by collapsed corporate parents but also take on “performing” funds.
It would also be run more along defined contribution (DC) scheme lines, where pension payouts are based on payments made into funds and investment returns. The proposals, the Institute argued, would create an efficient superfund, with the capacity to take more investment risk and achieve better returns.
The paper draws inspiration from Tory’s native Canada, with its large-scale public and private schemes. It also echoes developments in another vast pensions market, the Netherlands. Politicians there last week voted for a shift in the country’s occupational pension system from a DB to a DC model.
This aligns with British politicians’ thinking, too. Chancellor Jeremy Hunt plans to include the PPF proposal in a number of pension reform ideas. Rachel Reeves, the shadow chancellor, has similarly pushed pension reform. Both believe pensions could invest more in UK assets, particularly equities.
The pensions industry has been divesting UK equities over a long period. Since 2008, according to PPF data, the UK’s £1.4tn DB pensions system has slashed its exposure to listed UK equities from 29 per cent of its assets to 2 per cent.
There are clear reasons for this. One is diversification. Another is the growing importance of other markets, particularly the US. Most important of all, though, was the introduction of accounting rules which obliged schemes’ corporate backers to calculate a snapshot estimate of their long-term liabilities, using returns from current bond yields. This recognition spurred funds to cut risk, particularly exposure to equities.
The disinvestment is set to increase. As rising interest rates reduce projected liabilities, it has become more economic for the companies that stand behind DB schemes to transfer the risk of funding them to insurance companies.
According to advisers Lane Clark and Peacock, 2023 is set to be a record-breaking year for buyouts and buyins (a form of partial buyout), with a projected volume of up to £60bn of deals — double the average of recent years. Bought-out schemes do not typically invest in equities.
But is the PPF idea the fix? The fund is widely seen as a success. Less than 20 years after its creation, it manages about £40bn of assets on behalf of more than 5,000 schemes and has delivered strong investment returns, averaging about 9 per cent a year over 10 years, compared with 6 per cent for the average smaller DB scheme.
As a not-for-profit organisation, the PPF should be able to price buyouts more attractively for pension trustees and sponsoring companies than commercial businesses. It would also be less likely to sell out of equities. But it is a hard sell for trustees, and the pensioners they represent, to shift from a guaranteed DB environment.
Whatever the pros and cons of the PPF idea, reform of the system is vital. At least three other things need to happen. Accounting rules need to be re-examined. Any reforms must not involve government-directed asset allocation (though tax-based or other incentives could be effective). And plans to loosen some investment restrictions under Solvency II regulations must be carefully implemented.
Tugendhat’s interest in the topic is telling: portraying it as a matter of national security might be a stretch, but reform should certainly be a priority on the grounds of economic efficiency.
patrick.jenkins@ft.com