The Perils of Growth

01 January 0001

The consultation phase for the Government’s proposals on regulating Defined Benefit pension schemes has recently closed. Fundamental to the proposal is the need to support growing companies. Sustainable growth is the clear goal of government policy and correspondingly, The Pensions Regulator is asked to take into account the prospects for growth when agreeing targets for Defined Benefit pension funding.

A quick survey of UK companies reveals that the life expectancy of the average Defined Benefit pension scheme is rather longer than the life expectancy of their sponsoring companies. Indeed, the only remaining constituent of the original FTSE 350 to exist in recognisable form today is Tate & Lyle. The other 349 companies have acquired, sold, merged or mutated. This is even more profound in the US, where the 25 largest companies did not exist 25 years ago. Such is the pace of technological development and the rate of patent production that the prosperity of a copper-bottom stock, such as Kodak or IBM, can wane without warning.

Implicit in the Government’s ambition is a new category of investment risk to be borne by Trustees. Not only must they now pay attention to the investment risk implicit in their investment portfolios, Trustees are also being asked to carry covenant risk by compromising on contribution rates.

The Pension Protection Fund (PPF) is similarly put in jeopardy in that more schemes are likely to need to resort to this state safety net as assessment on the prosperity, which will be derived from sustained growth, is proved to be misjudged.

The acceptance of such increased risk might suggest that the discount rate to be used by the Trustees in calculating liabilities should be increased to reflect the less prudent approach being advocated. The net effect of course might well be to get schemes back to where they started. 

In parallel with the Government’s desire to rely on future growth, there has been a great deal of debate about the merit of long-dated government stocks, PFI state investment and infrastructure investment as ways of boosting the economy.

This direction of thinking would seem to have far greater merit. Paucity of long-dated fixed cash flows underpinned by a state guarantee or secured against real assets has frustrated investment committees of Defined Benefit pension schemes for decades. Complex and expensive financial instruments are being used to synthesise the cash flows required to match funding levels. A resurging economy boosted by investment in infrastructure guaranteed or at least supported by the State, feeds into Defined Benefit schemes – precisely the assets which they require. The dependency on the corporate covenant and indeed the corporates’ life expectancy is removed and the cost of investing reduced. 

Similarly, the dilemma of compromising technical provisions that are set to reflect a prudent expectation of future investment returns based on actual investment strategy are a potentially illusory projection of future corporate contributions. 

Finally, a dependency on long-dated and infrastructure investments would remove a complication for the calculation of the PPF levy. The credit assessment of the company and the extent to which the covenant is depended upon ought to create a higher levy under the sustained growth proposals than would be the case if Trustees were to depend on matched assets. Further thinking would appear to be required.

contact Mark Wood
Chief Executive Officer Mark_Wood@jltgroup.com 020 7309 8331