Monday 22 January 2018

Are QE pension deficits a big hidden problem in the economy?

Whenever a big company goes under these days, much of the post-collapse discussion surrounds the pension entitlements of former employees. The UK Government even has a Pension Protection Fund set up to try the best for the employees who are rightly seen as victims.


Dominic Chappell, of BHS infamy, even lost a court case this week for not sharing the information on his companies pension scheme with the Protection Fund - he may even get locked up for it.


But what has worried me for a long time is the destruction of the Pension industry since 1997 and Gordon Brown's raid on the tax relief on dividends in pension funds.


Since there all the UK defined benefit schemes have closed, these were more generous and could not be sustained after the raid. Also, the pension deficits of companies have grown, long-ago now are the pension holidays companies used to take in the 1990's.


In fact, the total amount raised by the Gordon Brown tax is around £150 billion (about £10 billion per annum, twice what it was alleged to be at the time). Today total FTSE350 deficits are around £17  billion, far from healthy.


On top of this then we have the Quantitative Easing fiasco which should ended 5 years ago. Now, we a very low interest environment thank to Banks and Funds being for by regulation to by Government Bonds which have increased in price, thanks to demand, and shrunk in yield. As a result, despite investing at around 6% more each year and having Pension assets double in the past ten years, pension scheme deficits are rising.


With all the money invested into pensions schemes, companies show less profits and in turn have less money to invest. One of the drivers of the UK economy, in a negative sense, is the lack of productivity driven by low investment. Companies that are struggling end up with no profits at all, see Carillion and others - pension deficits are a key driver toward corporate failure.


QE on top of the Brown reforms has destroyed the UK pension scheme industry. Weirdly, a re-balance economy with the end of QE would quickly see Deficits fall and pensions back to health (in their new defined contribution form which is about 1/3rd as good as the old defined benefit schemes).


It is a big underlying macro-economic challenge rarely addressed and as ever was an attempted Labour reform to the private sector gone wrong!

10 comments:

andrew said...

This could be a long rant, but I will restrain myself.

TL;DR
QE deficits are not a big problem or a hidden problem.
Blame lawson/Lamont.
Ending QE might actually make things worse.

Long version:

I was a trainee actuary in the late 80's. I would go with my boss to an SME in herts and he would say 'You want an N/60ths nra 65 best 3 last 10 final salary scheme and it will cost you 12-14%'. The client would nod.

The thing that I could not get past was that even then, I knew (we all knew)
- that this is a long term commitment for 50+ years and about 90-95% of company owners change over 20y
- that a change reduction in interest rates has a massive effect on the funding ratio.
This sense of doing something ridiculous, and slight numeric dyslexia prevented my actuarial career progressing.

So we knew about these things 20 years ago.

At that point in time the value of assets for funding purposes was 'actuarially adjusted' (based on the discounted value of future dividends) and so we had a lot of freedom to 'adjust'

Fast forward 25y and if that company still exists, chances are it has a f****** massive funding shortfall that is being recovered out of profits.

Why? - mainly
- regulation
- people living longer
- low interest rates


It is easy to put low interest rates down to QE, but a number of other things have impacted as well

- Regulation - returns on pension scheme assets were tax free until the *Lawson* budget of 86 - I remember the the angst of my elders as they even then recognised that once the door is opened worse will come, and then *Lamont* fiddled the ACT on dividend payments in the early 90s which then gave Brown an open barn door to whatever - so no party is innocent.
In this context, Brown is just some bloke who carried on with the abuse - a guilty bystander.

- Regulation - we used to value a pension scheme on the basis it would carry on being funded by the employer, (to some extent), we new have to value pretty much on the basis of 'the company goes titsup tomorrow and an insurance company takes everything over' i.e. highly secure gilt rates - which are more expensive.

- Regulation - highly paid people sheltered assets in pension schemes, so HMRC stopped that and so highly paid people now do not have much of their pension in a pension scheme along with all the other staff. So when things get difficult, they are not that invested (sic) in their company's pension scheme.

- Regulation - the very existence of the PPF has (sort of) forced companies to invest in safer assets as the govt does not want you taking risks. Safer assets have lower returns.

- Regulation - it feels like you cannot sneeze without passing the tissue past a lawyer.

- People living longer - this is a GOOD thing. Back in the 80s a 60 year old man would be expected lo live ~20 years. Now it is ~30.
On the downside, in a near 0% interest rate environment, that increases the cost of a pension by up to 50%.

- Low interest rates (QE)
Actually it looks like high interest rates were an historic anomaly (https://www.economist.com/news/finance-and-economics/21733988-property-yields-more-shares-and-bonds-investment-returns-outstrip-economic)

What happens when QE ends?
yes, the funding ratios will improve, but *not that much*.
also, ending QE will also add to the woes of many companies as interest payments will rise (as corporates issue the bonds many pension schemes own).

and the worst thing is ... that new DC scheme will probably cost you more to get the same level of benefit.





Nick Drew said...

very educational Andrew - thanks!

Anonymous said...

As above ... but you might want to revisit the issue of the apparent availability of cheap money for a long time and low productivity.

We should have been stuffing our factories and offices with the latest kit to boost productivity but not so.

CityUnslicker said...

Quite correct anon, but why? Pensions deficits are part of that answer, along with immigration and British propensity to sell out as soon as possible to foreign bidders.

Lord Blagger said...

At that point in time the value of assets for funding purposes was 'actuarially adjusted' (based on the discounted value of future dividends) and so we had a lot of freedom to 'adjust'

1. It's more of an issue with the regulator.

When you use AA corporate bonds with the assumption of no defaults to discount you underestimate the value of the liabilities.

2. It's an asset rate, why are you using it on a liability?

3. The reason, the regulator wanted to make pensions look secure. Picking a higher rate makes them look affordable when discounting over lots of years.

4. Move forward, and the liabilities are falling due. Doesn't matter what discount rate you use, they have very little effect when there's a year to go.

You know discover that your liabilities exceed your assets and there's a massive deficit.

5. Ever wonder why so many pension schemes are in the same mess? It's that discount rate again.

6. Why did so many banks get hit by people not paying their debts in 2008? The capital ratio was set too high. The regulator again.

7. Next problem. Watch the fraud from the state.

Carrilion, pensioners getting their pensions will get them paid, so its all safe. That's the con. They aren't saying what will happen to those yet to retire. They get screwed. The reason, the state will screw them because by the time they realize MPs have gone. Those retired will kick up an almighty fuss.

8. Collective pensions.

That's why collective pensions during the investment phase are disaster.

9. The state pensions? Assets zero

10. State pensions? Liabilities 10,000 bn hidden off the books.

So look back at the list? Who has their finger in every mess? The state. The state is the problem, not the solution .

DJK said...

> British propensity to sell out as soon as possible to foreign bidders...

This deserves more of a post. Why does this happen now, in Britain, when fifty years ago it didn't, and there were long term investors just like (now) in Italy or Germany.

Steven_L said...

Sooner or later they'll have to stop people transferring out of defined benefit pension schemes, to stop the run on them. Then again it's the government we're talking about, they'll probably **** up and fail to prevent a catastrophic run on pensions schemes, only shutting the stable door after the horse has bolted.

In the local government scheme the boomers (now entering their 30 to 40 year retirements on the old index linked 1/80 and 1/60 final salary schemes with a low retirement age) basically get first dibs on the money in my 1/49 retirement age 69 or 70 career average scheme. I wonder if there will be any left for me or whether I should keep transferring it out periodically (until they stop me) to invest in Asia?

Hmmm, a run on pension schemes, is this just a potential UK problem? What are the USA and rest of Europe like in this regard?

Lord Blagger said...

Sooner or later they'll have to stop people transferring out of defined benefit pension schemes, to stop the run on them.

Nothing like locking the young in, rip off the assets to pay existing pensioners, leaving nothing for the chumps.

The LGPS, the current scam is mergers. Merge the most bust with the less bust schemes, to delay the inevitable.

Anonymous said...

“Back in the 80s a 60 year old man would be expected lo live ~20 years. Now it is ~30.
On the downside, in a near 0% interest rate environment, that increases the cost of a pension by up to 50%”

Hmm, that is a very good point.

Lord Blagger said...

Life expectancy, if you get to retirement age in the UK is 18.6 years. Your 30 year number is too high.

Now the increase in life expectancy is 1 year a decade. 5% on the cost of your retirement.

Now if those pensions contributions had been invested, you wouldn't have a longevity problem.

It's because they were spent, in a socialist ponzi, that you have the problem even with the same longevity changes.

It's not longevity, its unfunded pensions that's the problem. The longevity argument is just the excuse for the scam.