Buyout readiness: a date for the diary

Everyone has different key dates in their life. For me – probably my wedding day, the date my kids were born, the date I tried my first open water triathlon and almost drowned in the docks at Excel London. Happy days. Key dates that shape the future. 

Last month, my pensions work experience clock ticked past 28 years. I enjoy the slightly more technical aspects of the subject (though I’m of the firm opinion that it’s impossible to know enough about pensions, and every day remains a school day). My work anniversary got me thinking – what are the key dates in pensions?

The list I’ve come up with shocked me a bit. Many may think 17 May 1990 and Barber, 6 April 1997 and abolition of GMPs, introduction of Pensions Act 1995, 5 April 2005 and the Pension Act 2004. 

But I’ll go with:

• 1 January 1986 – the date that revaluation of deferred benefits started to kick in. The date the government really started mucking about with the promises employers thought they had made.
• 16 September 1992 – the date the UK left the Exchange Rate Mechanism. In my mind, effectively starting a mindset in policymakers of low interest rates. At that point, pensions saving became a LOT more expensive. When I started in pensions, we discounted future cashflows at 9%. Today, closer to 2.5% might be considered the norm.
• 3 July 1997 – Chancellor Gordon Brown removed the ability for pension funds to benefit from Advanced Corporation Tax credits. A stealth-like move – I’d guess that at least 99.9% of the UK population are unaware of it. But, in doing so, he reduced by £billions the income pension schemes could receive on their investments. Making pensions yet more expensive. (A thought for another day – if it is that simple to carry out such a stealth move, how open to challenge is that £41 billion p.a. in tax relief currently enjoyed by UK pensions savers?!)
• 11 June 2003 – schemes sponsored by solvent employers had to pay the full buy-out debt from that date. Previously, they only had to pay the debt as calculated on the Minimum Funding Requirement (which was far less in most cases).
• 1 March 2013 – the last FTSE 100 Company (Shell) shut its pension scheme to new entrants. Not least, I would suspect, as a result of the events which occurred on the two dates above.

Why this combined set of dates is important

Every year the Pension Protection Fund (PPF) publishes a summary of the data it has collated in relation to schemes which qualify for the PPF. In 2020, this was a universe of 5,318 schemes with combined assets of £1.7 trillion. 

2020 wasn’t a normal year. 31 March 2020 CERTAINLY wasn’t a normal point in any form of market cycle – financial markets were in the midst of a crisis. Hence, the data from the 2020 set has to be treated with caution.

But what has happened since? As I write, global markets have largely (though not uniformly) rebounded. Gilt yields are starting to rise back up. As a result, the gap to buy-out is starting to decrease again for a large number of schemes.

What does the PPF’s Purple Book say about that gap? At 2020 schemes were on average (and the average clearly masks significant variations at a scheme-specific level) at a buy-out funding level of just over 70%. Where is it likely to be now? High 70%s? Schemes have been supported by broadly (2020 apart) stellar global equity market growth over the last decade. And companies have been making £billions in contributions to what is now an increasingly closed scheme population.

Why this is relevant 

Because I see a potential problem on the horizon. I’m not sure precisely how far the horizon is – it might be five years or 15 years. But eventually, the Finance Directors of sponsoring companies for the vast majority of those schemes – remember that is £1.7 trillion (and growing) – are going to want those schemes off their balance sheets. To some, they represent nothing but a volatile legacy headache. And whilst there are question marks about the insurance market’s capacity to write that sort of business, I’m also not sure that the pensions industry has the correct blend of skills to get those schemes effectively secured.

A scheme buy-in, buy-out and wind-up isn’t business as usual. It is a one-shot opportunity to secure liabilities. Get it wrong, and the assets of the scheme will no longer be there to support any subsequent claims, leaving trustees potentially personally liable.

But more than that, getting those schemes insured effectively involves massive transactions. A 1% change in the purchase price can equate to a premium of £millions. Getting the best purchase price requires skill, experience, planning, knowledge of the market, knowledge of the latest products and techniques, commitment and collaboration between all parties. 

When 11 June 2003 happened, we thought there would be a slow clamour for schemes to move to buy-out. But move they would. Shell was the last FTSE 100 Company to close to new entrants – from that date surely it was just a question of time and affordability before insurance became the norm? 

The PPF Purple Book evidences that over the years since 2003, about 1 to 2% of schemes have wound-up. I’d argue that there is potential for that rate to increase significantly in the coming years.  Maybe by a multiple of say, five?  If Superfunds get traction, that multiple could be even higher. 

Which gets me asking – is the adviser market, and are Trustees (whose take ultimate responsibility and must hold those advisers to account) ready??