The Society of Pension Professionals ran its annual conference online over three sessions last month, with the final session also taking place in person.
It was the session on ‘Defined benefit (DB) funds: transitioning to annuities’ that proved remarkably prescient, taking place just a week before UK chancellor of the exchequer Kwasi Kwarteng’s controversial mini-budget.
The result had been soaring Gilt yields, prompting a Bank of England (BoE) intervention of up to £65bn to support UK pension funds faced with mark-to-market losses in liability-driven investment (LDI) strategies, and margin calls on interest rate swap hedges.
Emily Tann, solution designer at Insight Investment, highlighted the importance of considering the impact of a buy-in on a scheme’s residual assets and liabilities, particularly as to whether it reduced the resilience of the LDI collateral.
“This year, rising yields mean many schemes have had to provide additional collateral to their LDI portfolios,” she said. “Schemes that have done buy-ins have suffered the most.”
She added: “That’s because they’ve handed over a lot of Gilts, probably their highest-quality asset from a liquidity and collateral adequacy perspective, to insure their pensioners, their less risky members. They’re left with an LDI portfolio with higher leverage and higher duration, so it’s more sensitive to an increase in yields.”
The panel had been asked to consider whether the UK’s £2trn-worth of DB liabilities could all be transitioned to bulk annuities in coming years.
Tann said, “Buying out is saying goodbye to your pension scheme when it’s at its most valuable and its assets only need to generate risk-free returns. The decision to buyout can be thought of in terms of who’s benefiting from future surpluses – the insurer, or the providers of the funds – ie, members.”
William Nicoll, chief investment officer, private and alternative assets, at M&G Investment Management, said: “Pension schemes are fantastic investment vehicles because they can invest just about anywhere they feel they should, and they provide a real benefit for the UK economy. Annuity funds are fundamentally stuck to investment-grade debt.”
He suggested that “huge moves” to bulk annuities could result in less ESG impact by pension funds.
He explained that one of the main drivers to the new economy is new technology, such as carbon-negative housing, but annuity funds cannot invest in those assets yet.
“If we do take that large chunk of money into annuities, we risk starving some new technologies,” Nicoll warned.
Scottish Widows expects UK bulk annuity business to total £25bn to £40bn over the next 10 years.
Matt Wilmington, head of origination for bulk annuities at Scottish Widows, considers that £2trn of liabilities moving to bulk annuities is an overestimate: “Some will run off naturally, and there are also other solutions. Bulk annuities are not right for schemes which need returns to get themselves to full funding.”
Wilmington emphasised that staffing is an important issue for insurers: “We all run teams of very smart people and the size of those teams limits the amount of liability we can take on.”
He warned that if demand for bulk annuities doubled, prices would rise, or insurers would not be able to price, leaving many pension schemes disappointed.
His advice to schemes was: “Make sure your data is ready, your benefits are sorted out, and your assets are in good shape. Make sure you’ve thought about whether a bulk annuity is right for the scheme, and you’ve got the right advisers.”
He expects few new entrants in the bulk annuity market, “because the current regulatory burden is too big for anybody who doesn’t already have very similar business lines.”
Pensions industry should focus on long-term implications
Conference attendees also heard from Charles Counsell, chief executive officer of The Pensions Regulator (TPR), now entering his final six months in the post.
Counsell warned the pension industry that while being alive to the economic impact of global shocks, it should focus on the long-term implications.
“The immediate impact of the pandemic took relatively little time to correct, but that’s not true of climate change, which will have a huge long-term impact on pension schemes,” he said. “This is why the government and TPR are focused on ensuring that all schemes consider the risks and opportunities of climate change.”
Of specific interest are the Task Force on Climate-Related Financial Disclosures (TCFD) statements. So far, 23 schemes have published reports, with a further 50 expected to see daylight soon.
“We are starting to review these statements and will provide feedback to industry to help with future preparation,” Counsell said.
“We are encouraged by trustees’ efforts, but know there are challenges, for example with the quality and availability of data. Those will reduce with time, as analytical techniques and methodologies develop,” he added.
Given the focus on large schemes with respect to ESG and climate reporting in general, his advice to smaller schemes was to think through the governance and risk management aspects applying to larger schemes, without necessarily conducting a detailed analysis, “because in the end, taking account of climate-related changes is important for all schemes”.
Asked about outcomes for defined contribution (DC) members, Counsell said: “The reality is that very few members are engaged. I hope the dashboard leads to additional engagement, but I think it’s a case of focusing on making sure decisions made on behalf of members are well made.”
He added that following the call for evidence by the Department for Work and Pensions on decumulation, as part of that it would be interesting to see if the collective defined contribution (CDC) model can be extended to decumulation.
TPR is currently developing its compliance enforcement strategy for the pensions dashboard, modelling it “quite heavily” on the approach taken for auto-enrolment.
“We will take a hard line on wilful non-compliance, but where schemes are making every effort to get it right, we will take a different view,” Counsell told attendees.
Meanwhile, the new code of practice on funding is expected to be published later this calendar year, while the single code of practice on governance – to include climate change aspects – is also imminent.
Later this year, TPR also intends to publish an action plan building on work by its diversity and inclusion industry working group which seeks to assist pension boards and employers, with guidance issued by the end of the current financial year.
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