Pension Corporation

Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, today announces that the Trustee of Walthamstow Stadium Limited Retirement Benefits Scheme has accepted a proposal to insure its benefits with Pension Insurance Corporation (“PIC”). The pension scheme has assets of £19 million.

Following the closure of the business, based around the former greyhound racecourse in East London, the pension scheme was closed to future accrual. The Trustee ran a competitive process which included several other pension insurance companies.

The Trustee concluded that the safety and security of member benefits would be secured through a full pension insurance buyout transacted with Pension Insurance Corporation. The Trustee was impressed with Pension Corporation’s business approach and willingness to do business on competitive terms.

Matt Barnes, Partner, Pension Corporation, commented:

“I am delighted that we were able to help the Trustee of the Walthamstow Stadium scheme arrive at a successful conclusion in securing their member benefits for the long term. We look forward to helping more trustees and sponsors transfer pension risk as the market continues to grow during the second half of 2009.”

Notes to Editors:

For further information:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Nick Henderson
+44 (0)20 7269 7114

Caroline Parker
+44 (0)20 7269 7295

About Pension Corporation

Pension Corporation removes pension risks from the sponsors and trustees of defined benefit pension schemes. As a market leader it is the counterparty to risks ranging from full buyout to longevity risk insurance, scheme stewardship and asset-liability management. It provides increased levels of security and stability for scheme members through Pension Insurance Corporation Ltd (“PIC”), a fully authorized and FSA-regulated insurance company; and Pension Corporation Investments LP Inc. (“PCI”). Pension Corporation is backed by a range of financial services firms including J.C. Flowers, Royal Bank of Scotland, Swiss Re and JP Morgan. For further information please visit www.pensioncorporation.com

The term “systemic risk” is normally used to describe the risk that idiosyncratic shocks affecting individual businesses could be transmitted throughout the financial market, with the result that the whole market could become unstable or even collapse. As the world economy has become ever more integrated, this risk has gradually increased over time but until recently appeared to be more a theoretical phenomenon than a real issue. Over the last year we have all seen how serious this risk is in the real world, with the collapse of Lehman Brothers nearly bringing the whole global financial system to its knees and pulling the world economy into recession.

Taking a slightly more liberal definition of “systemic risk” there are many other areas in which adverse developments in one part of the market could affect other parts, with the result that the overall structure could become unsustainable over time.

One such area is pensions; as it is the British pension system provides a particularly good example. The system is based on a highly complex structure, with the different players – individuals, firms and government – interlinked in myriad explicit and implicit ways. State pensions (with a large means-testing element but also an earnings-related component), occupational pensions (defined benefit but increasingly defined contribution based) and private pen sions (to be boosted by personal accounts in 2012) are all meant to work together to avoid pensioner poverty and enable pensioners to enjoy a quality of life similar to that prior to retirement. The issue becomes even more compli cated once the housing market, which provides an impor tant mechanism for building up assets to fund consumption in retirement, is brought into the equation. Government, quangos such as The Pensions Regulator or the Personal Accounts Delivery Authority, corporate sponsors and pen sion fund trustees, independent financial advisers and last but not least the individual (hopefully entirely rational, for ward looking and financially literate) all play pivotal roles to keep the pension system alive.

A failure of one part of the system to deliver what it is meant to deliver could jeopardise the smooth functioning of other parts of the system, making the entire structure eventually unsustainable. The key difference between the “systemic” risk in the British pension system and the financial markets is perhaps the time span over which the problems materialise and become apparent. In the case of pensions the developments are driven to a large extent by slow-moving demographic change so the collapse will resemble more a slow decline than a rapid wildfire. While the seriousness of the issue is perhaps similar, the slow col lapse at least gives plenty of time to act. Unfortunately, as we have seen again and again, it also gives plenty of time to procrastinate.

Looking back
So, what is wrong with the British pension system? To answer this question one has to go back at least 10 years. Up to the late 1990s the British pension system was charac terised by modest state provision aimed at alleviating pen sioner poverty and solid occupational pensions for those on medium or higher incomes, with defined benefit pension schemes widespread in the public and private sectors. Back then, around 60% of all pension incomes came from the state, the remainder from the private sector.

Since the beginning of the new century this tried and tested model has come under increasing strain, with corpo rate sponsors of defined benefit pension schemes waking up to the true costs of the promises made and increasingly struggling to make the required contributions to meet the government’s funding requirements for these schemes. Many corporate sponsors concluded that the only way for ward was to close their existing DB schemes and shift the risks associated with pension provision to the individual by offering defined contribution schemes instead.

Meanwhile, the government focused increasingly on targeting state pensions on those in greatest need by introducing first the minimum income guarantee and later the pension credit to keep state pension spending at a minimum. In an acknowledgement that not everything was rosy though, in 2002 the government established the Pensions Commission to develop ideas on how to help those on moderate earnings save for retirement while keeping the public finances sustainable. The Pensions Commission sug gested three major policy reforms, which the government more or less implemented as new policy: linking the basic state pension to earnings growth rather than inflation from 2012 onwards, increasing the state pension age from 65 years in 2010 to 68 years by the mid-2040s as a response to the projected increase in longevity and the establishment of personal accounts as a private savings vehicle for those on moderate incomes also by 2012.

This brief history of recent pension developments in the UK illustrates that the system was far from stable before the financial and economic crisis unfolded. The crisis has set in motion further developments as it has had an adverse impact on all aspects of the pension landscape.

The first development is the further decline of DB pensions in the UK – a trend that was not inevitable as a number of larger scale employers in the private sector appeared to remain committed to these schemes pre crisis. In June alone, BP, Morrisons and Barclays all announced the closure of their schemes either to new members or to future accruals, with the result that DB pensions have become exclusive to public sector workers. This means that most private sector workers have to deal with all the risks associated with pension provision – longevity, inflation, investment – on their own. In theory the crisis could also stress test the viability of the Pension Protection Fund, which was set up under the provisions of the Pensions Act 2004 to help members of DB pension schemes whose corporate sponsors have run into financial difficulties. Second, those in defined contribution pension schemes have also done badly, with the stock market offering dis appointing returns over the last 10 years and more. This leaves those close to retirement or contemplating buying an annuity with lower pension wealth than previously expected and perhaps looking for the government to make up any shortfall.

Retirement income
With businesses disowning – perhaps rightly in a changing world in which jobs-for-life no longer exist – their respon sibility to provide a guaranteed retirement income to their employees and individuals badly placed to deal with the risks they increasingly face, the role of government in ensuring reasonable incomes in retirement might have to be revisited. But the shock that has impacted on DB and DC schemes has also affected the government’s ability to help out. The economic crisis has been a major blow to the public finances in the UK, with the government now running one of the largest public deficits anywhere in the developed world. This leaves the government in a weak position to meet any potential demands from those on disappointing DB or DC pensions for higher state spending to fill the gap and could jeopardise the recent policy reforms before they have even been launched.

In other words, the continued closure of DB schemes and weak performance of DC schemes could stretch the govern ment’s ability to meet its own side of the pensions bargain, representing its very own kind of “systemic risk”. If this were indeed to happen then nothing but a complete rebuild of the UK pension system would suffice to put pensions on a sound footing in the first half of this century.

The buyout and risk reduction marketplace has grown significantly over the last 12 months – with buyout business topping £10bn in 2008 and expected to reach similar levels this year. Yet, the dramatic deterioration in the world economy from September last year has made traditional buyouts less affordable – as pension scheme asset values have fallen and company finances have deteriorated. Despite this, the need for companies and trustees to reduce risk in their scheme has increased markedly. This Conjecture will assess the case for buyout and risk reduction in the current economic environment – looking at how to reduce the immediate cost of buyouts, other routes to risk reduction, how a risk reduction strategy can work in practice and how the risk reduction marketplace will develop over the coming year.

John Fitzpatrick among panellists who are discussing the implications of deflation for trustees, the future of the longevity market, their attitude to quoting for smaller schemes, and the affect of annuity Costs of Solvency II.

The panel

Chairman: David Stewart, partner, Lane Clark & Peacock
Stewart is a member of LCP’s specialist buyout advisory team and since joining LCP he has managed the buyout of over £400m of liabilities including full buyouts and partial buyouts of pensioners.

Andy Reed, director, defined benefit solutions, Prudential
Reed is responsible for innovation within Prudential’s Defined Benefit Solutions, developing new routes to market. Reed led the transaction to secure the first insured £1bn pensioner buy-in (with Cable and Wireless) in September 2008.

John Smitherman-Cairns, corporate development director, Lucida
Smitherman-Cairns is a member of the executive team responsible for the development and delivery of Lucida’s pension de-risking offering to the UK market. He is a qualified accountant and joined Lucida from Prudential where he was head of corporate finance.

John Fitzpatrick, partner, Pension Corporation
Fitzpatrick joined Pension Corporation in 2006. Prior to this, he was a member of Swiss Re Group’s executive board and executive board committee. He served Swiss Re as the company’s chief financial officer, head of life & health business group and head of financial services.

Hugo James, sales development director, bulk annuities, Legal & General
James has overall responsibility for Legal & General’s sales in the bulk annuity market. He is focused on helping develop solutions and structures to support larger schemes seeking to de-risk.

Nick Johnson, head of defined benefit risk, Aviva
A qualified actuary, Johnson has headed up Aviva’s bulk annuity proposition since January 2006. He is currently working with a number of trustees bodies to develop innovative solutions to manage the transition to insured benefits.

Myles Pink, business development director, Paternoster
Pink is responsible for new business generation, negotiation of commercial terms, devising product structures and trustee/adviser relationships at Paternoster. Pink advised on the initial fundraising for Paternoster in early 2006.

STEWART: The UK has just moved into the first period of deflation for many years. What are the practical implications of deflation for trustees preparing for a buyout?

REED: While the increases to most occupational DB pension benefits are linked to inflation, this link is broken when inflation turns negative (becomes deflation). Many schemes who covered these benefits by investing in assets whose payments and value were themselves linked to inflation, will find that in 2009, while these assets have decreased with deflation, the benefits they are covering remain level, leading to a decrease in the level of funding. Some buyout providers may not offer a floor of 0% (leaving trustees with an uncovered liability), or may charge a premium for the extra risk they are taking on. Trustees therefore need to be aware of the type of assets they hold, whether or not they contain a hedge against the deflationary risk (usually options/swaps are required to provide the appropriate hedge) and whether these assets may be transferred across to the insurer via in-specie asset transfer. Schemes looking to undertake a buy-in should consider whether or not to insure the deflation risk with the insurer, or purchase appropriate assets within the market (note the inflation swap market is quite illiquid at this current time).

SMITHER MAN-CAIRNS: Most pension scheme benefits do not deflate. Benefits can only increase with inflation. Hence insurers taking on pension scheme liabilities need to hedge inflation with a floor of zero (and often with a cap of 3% or 5%). In today’s low inflation/deflation environment, the cost of hedging this risk increases. There is also limited availability.

Trustees of schemes having inflation linked benefits will need to work with insurers to address this lack of availability of hedges, for example by purchasing LPI swaps over a period of time so that by the time the trustees are ready to buyout, the scheme has a portfolio of swaps which can be passed to the insurer.

FITZPATRICK: Insurers will insure pension scheme benefits as agreed in the contract of insurance and this includes a floor of zero on RPI. Costing this is complex as insurers will consider inflation expectations over the full 20-50 years, not just over the next few years. It is better if trustees have some protection against inflation, even if this is not perfect protection, because over the long term we will see inflation – not deflation.

JAMES: Negative inflation is particularly relevant for LPI increasing pension benefits with a 0% floor, where deflation has resulted in this floor biting. Deflationary fears have resulted in liquidity in the LPI swap market drying up and prices increasing significantly. Insurers are therefore currently not able to pass significant amounts of LPI risk on to the capital markets and as a result their appetite for pension schemes with unhedged LPI exposure has decreased.

Where a scheme has existing LPI swaps in place, we are able to novate these swaps over to Legal & General to ensure the buyout can proceed. Where a scheme does not have the required LPI swaps in place, trustees may see better “value for money” securing benefits on a zero, or fixed increase basis with the ability to add indexation at a future date.

JOHNSON: A key consideration for trustees for all buyout transactions is to ensure that the benefits they think they are securing actually reflect the benefits provided by the policy. Inflation linked pension increases is an obvious area where a previously unthought of/unlikely set of circumstances and unclear policy documentation could lead trustees to be ‘under insured’.

PINK: When pension benefits are linked to inflation, the scheme rules refer to pension “increases” or “escalations”. In practice, trustees of UK pension schemes will not reduce pension payments in times of deflation and there is therefore an implicit floor in the inflation-linkage. When trustees insure the benefits of a pension scheme any ambiguity or subjectivity in the benefit structure needs to be clarified before codifying it in the insurance policy. Trustees preparing for buyout should ensure their scheme rules are clear on the application of a floor to inflation-linkage and ensure that insurers are including the cost of providing this floor in the premiums they charge.

STEWART: Babcock recently announced the first longevity swap by a UK pension scheme. In response, some commentators are predicting that the longevity market will grow rapidly while others are more sceptical. How do you think the longevity market will develop for the rest of the year and what are the main obstacles to its development?

REED: There is clear interest in longevity only insurance and we expect further deals to follow the Babcock announcement. However, longevity swaps are less likely to be a high volume solution compared with buy-ins, due to the costs and complexities involved in these swap deals. We therefore expect to see a few, larger schemes with high proportions of pensioner liabilities to be most interested.

There are two key considerations that may provide obstacles to this new market. The first is that longevity swaps only hedge against longevity risk, whereas buy-in solutions also mitigate investment risk and inflation risk as well. The second is that there is potential to become locked in to a swaps solution, which may prove restrictive when schemes ultimately look to secure a buy-in or full buyout at a later date. Trustees should carefully assess the structure of any longevity swap before transacting.

SMITHER MAN-CAIRNS: Longevity risk is a key risk facing the UK and for selected schemes, longevity swaps may represent a sensible step along the path to ultimate pension fund de-risking.

However, we would caution against over playing the potential role of this product as a solution for all schemes at present given uncertainties over the ultimate market capacity and the complex nature of this product. We would also highlight there is a cost for longevity risk transfer which is significantly subsidised by asset spread in buyout or buy-in structures. This subsidy is not available in a straight longevity swap transaction.

FITZPATRICK: With funding levels having taken a hit, many schemes are looking to protect against increasing longevity while retaining investment exposure in the hope of recouping losses. In this environment, longevity insurance has increased in popularity. Different forms of longevity protection are available. Protection through an insurance contract has advantages. It operates in an FSA regulated environment, is covered by the Financial Services Compensation Scheme, protects the specific members of the scheme and is unlimited in duration. The main obstacle to date has been “portability” – can the trustee switch cover or cancel the cover. This has now been addressed and demand will grow quickly.

JAMES: The longevity market is still in its infancy and while a large liquid market in longevity will benefit both pension schemes and insurers in the long term, it is unlikely that this market will be quick to develop. Individual transactions are bespoke and require significant negotiation between longevity providers, sponsors, trustees and their advisers before they can be completed. This complexity and the currently limited number of market providers mean that the longevity risk market is unlikely to grow rapidly in the short term.

It is likely the longevity market will grow to compliment the buyout market rather than being a competitor, as longevity only products do not protect schemes against investment risks which have proved to be far more volatile within schemes.

JOHNSON: The first longevity swap has been on the horizon for a number of years, and it was only a matter of time before a group of trustees took the ‘leap of faith’ and undertook a transaction. While the intellectual argument for such swaps is relatively easy to be made as part of an ongoing risk management strategy, there are a number of practical considerations which significantly complicate the use of longevity swaps.

As with any synthetic investment, I’d consider there are two main causes for concern, apart from the obvious counterparty risk: the first being sheer complication of how they operate in practice, and ensuring that they do hedge the risk effectively; the second, being what value (if any) the contract would have should the trustees need to realise assets.

PINK: A pension scheme can insure against principally two risks: longevity and investment. Current uncertainty about the extent to which investment strategies might perform in the future has led to increases in the cost of this component. Demand from pension schemes for a product that strips out investment risk insurance and focuses more on longevity is a logical reaction to the impact that widening corporate credit spreads has had on annuity providers’ reserving policies. Longevity swaps that are tailored to a defined group of members of a specific pension scheme are developing in sophistication.

There are two main obstacles: longevity risk is long-dated and the impact of that risk today appears small, so a swap may often appear expensive and longevity-only insurance is only a partial solution in the de-risking of a defined benefit pension scheme.

STEWART: With fewer schemes requesting buyout quotations in 2009 than last year, are you currently more willing to quote on smaller schemes? What is the minimum transaction size you will quote upon?

REED: We do not have a specific minimum transaction value and will assess each case on its own merits. With many large schemes struggling to afford large one-off transactions, there may well be an opportunity for smaller schemes to take action now. It’s important to note that for quotation purposes, a scheme’s ability to transact is more relevant than the size of the deal. Trustees that have made shrewd preparations (such as completing a data cleansing exercise and moving into appropriate assets), will find themselves in a stronger position and better able to secure the insured solutions that help them reduce their risk exposure.

SMITHER MAN-CAIRNS: We evaluate each new potential opportunity on a case by case basis looking at a range of factors including corporate and trustee buy-in to the affordability, process and scale. For all serious enquiries that meet our selection criteria, we will attempt to provide a quote on a timely basis. However, given the on-going interest in this area and our focus on developing customised risk transfer solutions, we need to manage the number of opportunities we take on and tend to focus on the larger end of the market.

FITZPATRICK: Pension Corporation has completed transactions varying in size from £10m to over £1bn. We have seen an increase in serious demand across the board – large schemes and small schemes. The economic situation has delayed completion of some buyouts and buy-ins but sponsors and trustees are more engaged than ever before. Companies want to remove legacy hurdles to developing their businesses, overseas investors want to restructure their UK operations, and trustees want to bring security and stability to member benefits.

JAMES: Legal & General remains committed to quoting on the broadest spectrum of buyout business, ranging from schemes with less than £1m of liabilities up to schemes with in excess of £1bn of liabilities. One of our key strengths is providing buyouts to smaller schemes. In 2008 we wrote close to 200 policies with the average buyout premium being approximately £10m.

JOHNSON: We have seen the number of quotation requests reduce, but I think it’s yet untested as to whether this results from a reduction in speculative requests that were unlikely to transact in the short term. As for transaction size, Aviva has always considered scheme size as only one of a number of factors that effect the decision to quote. Last year for example we transacted around 30 ‘small transactions’ and fully intend to continue this strategy going forward. It’s fair to say that we wouldn’t rule any scheme out on premium size alone.

PINK: No, we are tending to focus on complex solutions that require flexibility and innovation; these solutions are often being sought by large schemes, typically in excess of £25m.

STEWART: There has been speculation that annuity costs might increase by up to 20% due to the impact of stronger reserving requirements for insurers under Solvency II . Do you agree with this view? How else will the introduction of Solvency II affect pension schemes in the UK?

REED: The outcome of Solvency II is still uncertain as we are still in the consultation period for the implementing measures for this directive, but there are approaches being discussed that would have this type of negative impact. Pension schemes are not covered by the legislation but it is feasible that there would be some kind of future harmonisation which could have significant implications.

SMITHER MAN-CAIRNS: Although the Solvency II Directive was officially adopted on May 5, 2009, this is a “framework” Directive, which confines itself to the principles to which the new system would be subject. More detailed implementing measures will then need to be set down by the Commission which will be done following consultation with key stakeholders. A considerable level of uncertainty remains as to how Solvency II will affect bulk annuity writers in the UK.

In a recent speech, the Chairman of the FSA, Adair Turner, said: “The new Solvency II capital regime needs explicitly to recognize that there is an illiquidity premium in bond yields...”

Given the importance of this issue, we remain optimistic that the final regulation will recognise Lord Turner’s comments and we continue to work with the Association of British Insurers to that end.

FITZPATRICK: Solvency II will put in place a comprehensive and consistent risk framework for all insurers across Europe and this has to be welcomed. Pension Insurance Corporation has an existing strong and comprehensive risk-based approach to capital management, an approach we have been following since we started the business. This is reflected especially in conservative investment portfolios and credit default assumptions. While higher capital may be required under Solvency II, it is also likely that new means of risk transference will develop to the benefit of pension insurers, such that capital requirements are controlled and annuity costs do not rise as significantly as some market commentators predict today.

JAMES: If the recent EU directive on Solvency II is implemented in its current form, it is likely to significantly increase the cost of annuities. We believe that the one-size fits all approach of Solvency II is not appropriate to the UK’s annuity market and that a more appropriate solution will be found before Solvency II is implemented. However, the risk of regulatory change cannot be hedged so trustees who are in a position to enter into a buyout now should consider acting sooner rather than later, as should regulatory uncertainty continue then prices may increase as the implementation date for Solvency II approaches.

JOHNSON: It goes without saying that any additional costs for insurers will at some point be reflected in increased annuity prices, and increased capital is a significant factor in the pricing of annuities. That said, it is early days yet, and the extent to which Solvency II actually increases capital costs for a given insurer will undoubtedly be something that emerges over time.

PINK: Current proposals mean that the implementation of Solvency II will result in a marked increase in annuity costs. The level of the increase is difficult to gauge as insurers are yet to obtain approvals for the models they intend to use to evaluate their capital requirements, but increases of 20% are possible. The model approval process is something which could take several years and the likely increase in cost will become clearer over this timeframe.

Although defined benefit pension schemes share many of the same risks as insurers, they are exempt from Solvency II requirements. Therefore the most likely impact on UK pension schemes will be a restriction in their ability to de-risk the scheme through the use of insurance due to the increased cost of doing so.

Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, was named “European Breakthrough Firm of the Year” at the European Pensions Awards 2009. The Awards ceremony was held on Thursday, 9 July, in London.

The judges recognised Pension Corporation as having broken into a challenging market and displaying “a sensitivity to the individual pension market needs”, as well as Pension Corporation’s pioneering efforts in the field of longevity risk transfer.

John Coomber, Executive Vice Chairman of Pension Corporation, commented:

“Pension Corporation strives to offer the best risk transfer solutions available to trustees and sponsors of defined benefit pension schemes. Over the past year we have insured the benefits of around 35,000 pension fund members including both the first transfer of pension liabilities out of the public sector with the Food From Britain pension scheme, and the largest ever UK corporate pension insurance transaction, Thorn.

“Pension Corporation’s products and services have one aim: to bring security and stability to the benefits of members of defined benefit pension funds. We will continue to build on this offering.”

Notes to Editors:

For further information:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Rob Bailhache
+44 (0)20 7269 7200

Nick Henderson
+44 (0)20 7269 7114

Caroline Parker
+44 (0)20 7269 7295

About Pension Corporation

Pension Corporation removes pension risks from the trustees and sponsors of defined benefit pension funds. As a market leader it is the counterparty to risks ranging from full pension insurance buyout to longevity risk insurance, sponsor stewardship and asset-liability management. Established in 2006 by the Truell Charitable Foundation, the Group now provides increased levels of security and stability for fund members through Pension Insurance Corporation Ltd (“PIC”), an FSA authorised and regulated insurance company; and Pension Corporation Investments LP Inc. (“PCI”). For further information please visit www.pensioncorporation.com

Pensions are an increasing issue of concern. Almost every day we see stories on the closure of defined benefit pension schemes, the iniquity of public sector pensions, the outcries against increasing the retirement age and a host of other pensions-related problems.

Yet few commentators get to the heart of the matter: that these individual issues – big as they are – are symptoms of a wider malaise in the provision of pensions in this country.

What we have seen over the past couple of decades is pension risk being reorganised in an ad-hoc, unsystematic fashion, with little regard for the law of unintended consequences. The net effect of this reorganisation is that the long-established system of pooled risk in pensions is being broken down, with pension risk being pushed down on to the unwilling individual.

Today’s occupational pension liabilities, whether unfunded or funded, public sector or private, are bigger than Britain’s GDP. Add in state pensions, projected to be 6% of GDP every year over the next couple of decades, and the scale of the issue is immense.

As society feels the full effects of the ageing of the baby-boomers, increased longevity and the hangover from the recent debt-fuelled economic party, it is possible to see social unrest, such as some European countries have experienced over this issue, and inter-generational dispute. We must therefore act to create a more equitable, efficient and sustainable system, one in which pension risk is distributed across the board and is therefore manageable for all.

A good example of managing risk has been the pension insurance industry. To help maximise returns, pension insurers have been adopting more sophisticated investment techniques than those typically used by many corporate-sponsored pension funds.

The enhanced portfolios they employ seek to match the duration of the pension liabilities, incorporate greater inflation protection and more closely match cashflows with liabilities. These investment techniques include the use of reinsurance, swaps and more sophisticated asset management strategies.

If the move to individual provision continues with increasing numbers of people in defined contribution pensions, how many of them will be able to use these techniques to ensure a comfortable retirement?

Yet it is clearly not right for corporates to bear the pension risk. In many cases the sponsors of final salary schemes have themselves become enmeshed in a web of pension-related problems they are ill-suited to handle.

For example, British companies have been forced to increase by a factor of 30 the money they put into pension funds to plug deficits since the 1970s. In 2000, British companies were putting £9.2bn into their pension schemes; by 2007 that figure was £33.6bn.

There are many companies in the FTSE 100 facing liabilities that far outweigh their current stock market value. The knock-on effects for the balance sheet and cashflow can be significant, potentially lowering profits, increasing leverage and ultimately, impacting their share price. For them, unloading pension risk is the logical solution.

A recent survey showed that three quarters of companies offering defined-benefit schemes were considering ending all future accruals for existing employees. Recent high-profile examples of this include Barclays and Wm Morrison. We could end up in this country with a system where the only benefits that are secured for the long-term are those of public sector workers.

Politicians of all parties must grasp the nettle and start thinking about the pension system today. In my view, it is essential that we have a national debate without pre-set boundaries around the shape of the provision for our old age: where the risks reside and the best solutions for spreading it equitably, efficiently and sustainably.

Without such a debate, taking full account of the role of the state and the interaction between state provision and occupational pensions, future generations will be left with an unmanageable burden – our old age. The answer is a review to create a system of pension provision fit for the modern age. This might well incorporate some of the features which made pension provision in the past so strong. After all, some of the challenges may be new, but the objective is the same. A good place to start is with a national debate.

Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, has today announced the appointment of Schroders to manage an initial £100 million segregated Global Corporate Bond Portfolio for Pension Insurance Corporation.

Mark Gull, Partner at Pension Corporation, commented:

“Schroders was chosen against strong competition because they not only demonstrated a sound process for managing corporate bonds and a well resourced team but, most importantly, they also clearly understood Pension Insurance Corporation’s goal of securing member benefits for the very long-term, and showed the flexibility to work with us in achieving this.

“Investing in Global Corporate Bonds in a mandate designed in partnership with Schroders, helps to maintain Pension Insurance Corporation’s strong risk discipline and enhances the diversity of its portfolio.”

Paul Forshaw, Schroders Head of Insurance Asset Management, said:

“By using Schroders' state-of-the-art Portfolio Modelling technology alongside our rigorous Credit analytics process, we were able to work with Pension Insurance Corporation to develop a customised investment solution to meet their very specific requirements. We see this as the start of a lasting partnership with Pension Insurance Corporation as we continue to work together to meet the challenges of constantly evolving client requirements and a changing market environment.”

Notes to Editors

For further information, please contact:

Schroders
Estelle Bibby
+44 (0)20 7658 3431

Pension Corporation
Jeremy Apfel
+44 (0)7966 138481

About Schroders plc

Schroders is a global asset management company with £103.1 billion (EUR 111.3 billion / $147.7 billion) under management as at 31 March 2009. Our clients are major financial institutions including pension funds, banks and insurance companies, local and public authorities, governments, charities, high net worth individuals and retail investors.

We apply our specialist asset management skills in serving the needs of our clients worldwide. With one of the largest networks of offices of any dedicated asset management company and over 250 portfolio managers and analysts covering all the major investment markets, we offer our clients a comprehensive range of products and services.

Further information about Schroders can be found at www.schroders.com or on Schroders Talking Point www.schroders.com/talkingpoint.

Issued by Schroder Investment Management Ltd, which is authorised and regulated by the Financial Services Authority. For regular updates by e-mail please register online at www.schroders.com for our alerting service.

About Pension Corporation

Dealing with the current economic crisis and its aftermath will undoubtedly top government’s priority list over the coming decade. This will be closely followed by healthcare policy and reform of the pension system in its totality: public sector, corporate provision, private provision and the basic state pension.

As a first step in this process it is essential that we have a national debate around provision for our old age, specifically looking at the levels of systemic risk, how this is distributed and ultimately who bears the cost.

The current reallocation of the financial burden of pensions among government, businesses and individuals, which at best is unplanned, is significantly affecting the future welfare of large chunks of the population.

If there is no coherent strategy, it will inevitably be the taxpayer of the future, our children and grandchildren, who picks up the tab.

Current liabilities are huge. There is a total of approximately £1 trillion of private defined benefit pension liabilities in the UK. According to one recent report, unfunded public sector pension schemes have an accumulated liability of £1.1 trillion. Add in the state pension, defined contribution, local government and other assorted occupational pension liabilities and these numbers mushroom.

The underlying drivers pushing this issue comprise increased longevity, ongoing ad-hoc regulatory changes, economic crisis and more general societal changes, including the ageing of the baby boomers.

Over the past decade, policymakers in many countries have shifted the longevity risk in future pension provision away from the state and on to firms and individuals.

As firms move away from pension provision, this risk is by default pushed down on to the part of the system least able to deal with it – the individual. It is all but certain that this unplanned move will haunt future generations.

Many corporate sponsors of final salary schemes have pension-related problems. In 2007, British companies were putting £33.6bn into their pension schemes to help plug deficits, so it is hardly surprising that companies are looking to offload pension risk.

We cannot afford to brush this under the carpet, nor can we afford to get it wrong. A national debate is the right place to start.

This Government, or the next, needs to grasp the nettle without any further procrastination.

A new report from Policy Exchange today revealed the true extent of the public sector pension debt, which until now has been kept hidden and out of official figures. The cost of these schemes is much larger even the publicly acknowledged national debt. Taken into account with net public sector debt, this second national debt brings the total the Government owes to £1.854 trillion, or 150 per cent of GDP.

Public Sector Pensions: The UK’s Second National Debt reveals that:

Using the Government’s own calculations, the accumulated liability of unfunded public sector pensions schemes is estimated to be greater than the national debt. If proper financial methods are applied, the true figure is vast - £1.1 trillion, or equivalent to 78% of GDP. (Page 5 & 33)
The cost of servicing the debt each year to pay for these unfunded schemes in now £45.2 billion. Even on the Government’s own figures, in 2005-6, the interest paid on the unfunded liabilities exceeded the interest paid on the National Debt for the first time. (Page 35)
The Government has been using financially indefensible methods to work out its liabilities and how much workers need to contribute to the schemes. (Page 32)
The Treasury has been subsidising pensions promises. The result is that someone who has been in the public sector for their whole career can now leave with a pension higher than the average they received when working. Neither the Treasury nor Parliament explicitly recognise they are paying this subsidy, which accounts in part for the rapid growth in liabilities. When added to the known subsidy, this means each of the five million employees in unfunded schemes receives a pension payment of £5,700 per year. (Page 42)
Younger workers and those on lower salaries are subsidising older workers and high fliers. (Page 18)

Neil Record, author of the report and renowned pensions expert, said:

“The Government has allowed public sector pension liabilities to run out of control, with the Treasury spending contributions received for the next generation’s pensions to the pay the current generation of pensioners. The Government’s accounting for these pensions has been arbitrary and opaque, making it all but impossible to understand.

“Public sector workers deserve security in retirement. But the worry is that in denying the extraordinary generosity of the current schemes, the Government is creating an apartheid, when compared to those of the private sector. This could lead to high quality public pensions being completely abandoned - I want to avoid that.

“The Bank of England has already moved to make its schemes 100% funded. If the Government were to do the same, the changes would be costly – but the reality is this isn’t money that would otherwise have been saved, and we urgently need to bring transparency to the cost of these schemes.”

The report makes a number of recommendations that would make the total costs of public sector pensions much clearer. These include:

For public sector employers that make pension provision for their staff to pay (jointly with employees for contributory schemes) a cash amount each year equivalent to the full market value of the pension benefits (i.e. current service cost) accrued by staff in that year.
For annual cash pension contributions to be used to buy index-linked gilts of sufficient value to fully pay for all pension promises made in that year. The index-linked gilts should be purchased and issued at market prices.
For a new body to be established (the Public Sector Pension Fund or similar) to receive contributions, to buy index-linked gilts, and to pay public sector pensions. The Public Sector Pension Fund should be required to break even, and charge public sector employers and employees accordingly.
For the existing public sector pension liabilities to be ring-fenced by the Treasury and allowed to run off over their remaining life. All outstanding public sector pension obligations should be met in full.
That the new arrangements should begin after a transition period starting from the date these (or similar) proposals become Government policy. This will allow for the establishment of the Public Sector Pension Fund, and for negotiations over the future shape of pay and pension packages.

Notes to Editors:

Net public sector debt was £754.0 billion at the end of April 2009 http://www.statistics.gov.uk/cci/nugget.asp?id=206

A full copy of Public Sector Pensions: The UK’s Second National Debt is attached.

This report was supported by Pension Corporation.

About Pension Corporation

Pension Corporation is committed to helping facilitate a debate around pensions, including public sector pensions, through its own published studies and research, sponsorship of other reports, public debates and other initiatives.

For further information please contact Amy Fisher on 07799 624 594 or amy.fisher@policyexchange.org.uk

Pension Corporation, a leading provider of risk management solutions to defined benefit pension funds, today announces that the Trustees of the Warwick International Group Pension Scheme have agreed a pension insurance buyin agreement, to insure members’ benefits with Pension Insurance Corporation (“PIC”). The transaction relates to retired pensioners only and the liabilities are valued at approximately £57m. PIC will in due course also take over responsibility for the administration of these pensions.

The pension insurance buy-in means that the insurance policy will be held as an asset by the Warwick International Group Pension Scheme and will offset liabilities, bringing greater security to members’ benefits. The pensioners remain members of the Scheme.

A pension insurance buy-in is a key step towards fully de-risking a pension scheme. By reducing the overall level of pension risk and investment volatility faced by a scheme, it allows flexibility for sponsor and trustees to explore other options.

Warwick International is a leading supplier of speciality chemicals, headquartered in the UK with chemical distribution companies throughout the world. Warwick was acquired in August 2008 in a management buyout backed by Close Brothers Private Equity Capital (CBPE Capital LLP).

Pension Insurance Corporation is fully authorised and regulated by the FSA.

Phil Kelsall, as Chair of the Trustees, said:

“We are delighted to have appointed Pension Insurance Corporation as our partner in this insurance buy-in. For us, this is a crucial step in de-risking the Pension Scheme and increases the level of security for our scheme members. We were able to secure the insurance contract at a price within our funding provisions, so this seemed to be particularly good value.”

Steve Williams, Finance Director, Warwick International Group, said:

“We are pleased that the pension scheme Trustees have secured this insurance contract, which we believe represents the best outcome at this point for the members of the pension scheme. It adds a new level of security to members’ benefits by reducing the scheme’s exposure to risk.”

Edmund Truell, Group Chief Executive of Pension Corporation, commented:

“We are delighted to have been able to help the Trustees of Warwick International Group Pension Scheme increase the level of security of members’ benefits. Pension Corporation is clearly in the market to write new business and has the capital to do so. We maintained a conservative investment stance throughout 2007 and 2008 which, together with disciplined pricing, places us in a strong position to work with trustees today to help them achieve their aims. We look forward to further transactions in the near future.”

Notes to Editors:

For further information:

Pension Corporation
Jeremy Apfel
+44 (0)20 7105 2140

Financial Dynamics
Rob Bailhache
+44 (0)20 7269 7200

Nick Henderson
+44 (0)20 7269 7114

Caroline Parker
+44 (0)20 7269 7295

About Pension Corporation

Key points

The economic crisis has highlighted not only weaknesses in financial markets and regulation but also in existing pension systems in many countries. The UK provides a powerful example for this.
Traditionally the British pension system has been characterised by a partnership between public and private sector, with the former providing a safety net for all, while the latter enabled those on average or higher incomes to enjoy a relatively high quality of life in retirement. For the majority of pensioners and pensioner couples, state benefit income was the main source of income in retirement though. Despite this, state pension spending is low relative to that in most other OECD countries.
Even before the crisis, British pension arrangements appeared unstable, with the government introducing reforms to, among other things, boost private pension savings for those on low to medium incomes (Personal Accounts). The key development in the private sector was the closure of defined-benefit (DB) pension schemes, with most employees moved to defined-contribution (DC) schemes instead. This trend was not repeated in the public sector. The UK’s public finances were in relatively good shape.
The crisis has affected all parts of the British pension system. First, unemployment has increased, potentially leaving more people with broken employment records. Second, the net funding position of UK DB pension schemes deteriorated sharply, encouraging the CBI among others to warn that corporate sponsors should not be forced to close the funding gap as this could exacerbate the crisis. Third, the value of assets in DC schemes dropped equally sharply, leaving those close to retirement with substantially reduced wealth. The Bank of England’s decision to lower interest rates and use quantitative easing further penalised savers and those who were considering purchasing an annuity. Fourth, the public finances have deteriorated dramatically, leaving the UK with one of the biggest structural deficits of any developed country. Fifth, in an effort to protect disposable incomes, households have cut back on retirement savings.
The crisis has left all aspects of the British pension system in a weakened state and it is unlikely that it will return to its pre-crisis status once the economy recovers.
The first reason for this is the perilous state of the public finances, with future governments – of whatever hue – required to cut spending and raise taxes to return its finances onto a sustainable path. This could jeopardise the current government’s policy to link the basic state pension to earnings growth by 2012. It could also provide the background to more radical public sector pension reforms.
Equally, the crisis will most likely encourage the remaining corporate sponsors of DB pension schemes to close these down and offer other arrangements to their employees instead. Personal Accounts, which are scheduled to be launched in 2012, could provide a useful benchmark.
There are also question marks over Personal Accounts themselves. When launched, the government believed that individuals would have too much inertia to actively opt out of these accounts. However, with households facing a substantial hike in the tax burden, individuals might conclude that they cannot afford to help the government reduce its debt burden and save for retirement at the same time. As a result many more people than previously expected might opt out, undermining the rationale of the 2006 pension reforms.
The bleak outlook should not only be seen as a challenge but also as an opportunity to create a more efficient and equitable pensions landscape. This would require a new division of responsibilities between the state, business and individuals.

Executive summary

This paper focuses on an issue, which so far has received relatively little attention by policy makers and the media, namely that the economic crisis has highlighted inherent weaknesses in existing pension systems in many countries. Using the example of the UK, the paper argues that the economic crisis will usher in further changes to the future provision of pensions, with the role of the private and public sectors likely to evolve in the years ahead. To support this argument, the paper first presents the pension landscape in the UK prior to the crisis, which was dominated by the closure of defined benefit pension schemes in the private sector and the government’s reform efforts. The paper then describes the impact of the economic crisis from both a macroeconomic and financial perspective on all aspects of the pension system, from the government’s deteriorating public finances to the collapsing funding position of occupational defined-benefit and defined-contribution schemes. The paper concludes by suggesting that the crisis has left the British pension system in a weakened state and that it is unlikely that it will return to its “pre-crisis” status once the economy recovers from the crisis.

Read the full paper here.