A] Prelude
For more information on pension systems, risk and coverage, feel free to visit our dedicated webpages:
https://expatpensionholland.nl/uk-expat-pensions
https://expatpensionholland.nl/global-pillars-systems
https://expatpensionholland.nl/global-investments-risks-0
https://expatpensionholland.nl/global-social-security-coverage
B] The Issue
For many years, old-style pensions were a headache for companies. Defined benefit (DB) schemes sucked in cash after the financial crisis, as low interest rates, rising life expectancies and a lack of new member contributions caused deficits to swell. Now the tide has turned. Higher rates mean businesses that were recently spending billions of pounds to ensure they could provide for retirees now find themselves in surplus.
This hasn’t gone unnoticed. The government wants to change pension rules to “unlock” this extra capital to fuel economic growth. This has implications for listed companies – particularly for banks, which could target higher returns, and life insurers, which could come under pressure.
There is a “fundamental asymmetry” in the current pension system, according to WTW. While funding shortfalls must be addressed with contributions, access to surplus funding is restricted. In nearly all cases, companies can only get their hands on the money in a ‘buyout’ scenario.
A buyout is a financial agreement between a DB scheme and a life insurer, where the insurer takes on the responsibility of paying the pensions. The company, meanwhile, can wind up the scheme and remove the liabilities from its balance sheet.
Under its new proposals, however, Labour wants to help companies access “trapped” funds before schemes are wound up and use them to “increase the productivity of their businesses”. This could incentivise schemes to run on, rather than offload risk onto an insurer as soon as possible. Not least because they could generate an even bigger surplus by continuing to invest.
C] Don’t bank on it
UK banks have the biggest final salary schemes in the UK private sector and shareholders could be in line to benefit. “Our pensions team believes that this could unlock additional shareholder returns for shareholders of some banks over time,” said RBC. The reasoning goes that banks could access a portion of their surplus and return it to investors via dividends. Alternatively, they could "re-risk" their pension schemes – invest in higher-returning assets, such as equities – grow the surplus and generate even more cash.
It is still unclear, however, what companies will be allowed to do. In its announcement, the government gave the example of buying equipment, boosting wages and making more money for pension scheme members. Paying out dividends is a very different proposition, and raises the knotty question of who the cash belongs to: Shareholders, pensioners, or the existing workforce?
D] Final salary pension reforms must protect retirees
Some companies have largely addressed this issue. At NatWest (NWG), for instance, any surplus that remains once its DB scheme has been wound up will go to pensioners rather than the company. In many cases, however, this is a source of controversy between trustees and the sponsoring employer.
There is a pressing practical issue as well. The big UK banks are all reporting pension surpluses in their annual reports, but there are lots of different ways to measure assets and liabilities. Buyout valuations are far more conservative, for example, than the figures quoted in company accounts. Analysis by RBC found that only HSBC would realistically have any surplus to “unlock” at this point in time.
E] Insurance policy
This is relevant when thinking about the impact on insurers. The recent surge in de-risking transactions has been a boon for the life insurance sector and the likes of M&G and Royal London have recently entered the market.
There are concerns, though, that Labour’s plans could weigh on sentiment – particularly around Legal & General and Phoenix, which target the largest schemes where run-on is the most viable. Just Group could also be affected by higher competition for small and medium-sized deals, according to RBC.
Others are far more relaxed, however. Panmure Liberum argued that it would only be sensible to access part of a surplus “after a material amount of hedging has been undertaken to lock in the current surplus”. Otherwise, the schemes might require more cash should economic conditions change.
“An exact hedge is typically only achieved by offloading the liabilities to an insurer via a buy-in or buyout”. A buy-in is another de-risking strategy where an insurer assumes a portion of a scheme's liabilities, rather than taking on all obligations. There is also doubt about how much money Labour has to play with.
“The headline figures of the potential surplus are vastly overestimated. We think the realistic surplus that can be accessed is around £60bn.” In her announcement, chancellor Rachel Reeves said approximately 75% of schemes are currently in surplus, worth £160bn.
F] Finally
The government intends to set out its surplus policy this spring and, until then, details are thin on the ground. One thing is certain, however. Figuring out how to free up surpluses, who should get the funds and how much risk is appropriate will be a headache all of its own!