Defined Benefit Pension Schemes Research Articles

The Role of Longevity-Indexed Bond in Risk Management of Aggregated Defined Benefit Pension Scheme

The Role of Longevity-Indexed Bond in Risk Management of Aggregated Defined Benefit Pension Scheme

Employees' Perception of the Contributory Pension Scheme (CPS) and Its Implementation Effectin Malawi’s Shire Highlands Education Division.

There have been dynamics in the pension systems globally which have witnessed various countries embracing the pension reforms within their Pension Scheme arrangements in respective jurisdictions. This evolution compelled Malawi to introduce the Contributory Pension Scheme (CPS) in 2011, targeting all employees, but received it with mixed feelings. This study purposed to establish public secondary school teachers’ perception of the CPS and its implementation effect. The study was guided by three objectives which were; to assess secondary school teachers’ knowledge levels of the CPS; to describe the perception of secondary school teachers about the CPS, and to establish factors that influence secondary school teachers’ perception of the CPS. A mixed method approach was used with questionnaires and scheduled interviews as data collection tools. Slovin’s formulae was used to derive the sample size of 240 employees from the 2000 target population. Purposive and random sampling were used as sampling techniques in which 240 were targeted for questionnaire administration on drop-and-pick-basis, while 5 respondents were selected purposively for qualitative data collection through scheduled interviews. Descriptive statistics was used to analyze quantitative data using SPSS V25 while qualitative data was firstly organized, reviewed and later themedfor content analysis. The response rate was 90.8%. The study results show that secondary school teachers’ knowledge levels of the CPS are low as indicated by 50% of the respondents. Similarly, 57% stated that they do not accept the CPS as a replacement to Defined Benefit Pension Scheme (DBPS) owing to the haphazard manner in which it was implemented with a strong perception that it was devoid of stakeholder consultation / engagement.On the other hand, 62% stated that they did not receive required scheme transaction and funds information of the new pension scheme as a major factor for the none acceptance, contrary to the aspirations of the Agency-Principal Theory. To this effect, the study concluded that despite the many merits of the CPS, employees are lacking some basic information on how their contributions are made, kept, and the pre-retirement utilization of the same by the Administrative Managers. Therefore, the study strongly recommends a paradigm shift in the management and administration of the scheme, by among others, entrenching principles of corporate governance of being transparent, accountable, ethical, responsible, and responsive to the primary stakeholders’ information needs from government and Administrators / Managers of the scheme in the manner of handling the funds on behalf of the pensioners as the same has implications on employees’ work motivation. There must be intentional communication to all pensioners in raising awareness of all activities related, and /or incidental to the pension scheme in order to demystify all misconceptions and negative publicity of funds misuse by the Administrators and Managers.

Report of the target end-states for defined benefit pension schemes working party

Abstract Running off the £2 trillion of UK corporate sector defined benefit liabilities in an efficient and effective fashion is the biggest challenge facing the UK pensions industry. As more and more defined benefit pension schemes start maturing, the trustees running those schemes need to consider what their target end-state will be and the associated journey plan. However, too few trustee boards have well-articulated and robust plans. Determining the target end-state requires a grasp of various disciplines and an ability to work collaboratively with different professional advisers. This paper sets out issues trustees, employers and their advisers can consider when addressing whether their target end state should be low- dependency, buyout or transfer to a superfund. Member outcomes analysis is introduced as a central tool through which to differentiate alternative target end-states. A five-step methodology is set out for deriving an optimal target end-state for a scheme. Also considered are the specific factors impacting stressed schemes, which highlights the importance to trustee boards when considering their Plan B should their employer or scheme ever become stressed. The paper ends with specific recommendations for the actuarial profession and The Pensions Regulator to take forward.

Considerations for actuaries when advising on commutation rates

Abstract This paper sets out the working party’s view that for a defined benefit pension scheme’s commutation rate the appropriate starting point should be to set it in line with the scheme’s cash equivalent transfer value basis. We recognise that there may be several reasons why an actuary in their advice may deviate from that starting point and we explore these in detail, giving our views on when deviation is and is not justified, noting that many common reasons used such as selection risk are often used without (in our view) adequate justification. We also cover frequency of review – our view is that commutation rates should be reviewed at least every 3 years and actuaries should consider performing a high-level review of commutation rates annually. We suggest that actuaries should consider proposing market-related commutation rates especially in periods of volatile market conditions. In terms of timing, there are good arguments to review commutation terms either following or during a valuation. Finally, we set out some considerations on how actuaries should present their advice, such as clearly setting out all the information required to take key decisions, following up with any actuarial certification in writing (if necessary) and illustrating the impact on members for changing commutation rates.

Climate scenario analysis for pension schemes: a UK case study

Abstract This paper demonstrates how climate scenario analysis can be used for forward-looking assessment of the risks and opportunities for financial institutions, using a case study for a UK defined benefit pension scheme. It uses a top-down modelling tool developed by Ortec Finance in partnership with Cambridge Econometrics to explore the possible impacts of three plausible (not extreme) climate pathways of the scheme’s assets and liabilities. It finds that the funding risks are greater under all three climate pathways than under the climate-uninformed base scenario. In the absence of changes to the investment strategy or recovery plan, the time taken to reach full funding is increased by three to nine years. Given that most models currently used by actuaries do not make explicit adjustments for climate change, these modelled results suggest it is quite likely that pension schemes are systematically underestimating the funding risks they face.

Offsetting Risk in a Neoliberal Environment: The Link between Asset-Based Welfare and NIMBYism

Affordable housing policy in the developed world has been undergoing a systematic commodification for several decades, including a push for homeownership as the normalized tenure and a commodity unto itself. Scholars suggest this push for homeownership is part and parcel of a neoliberal asset-based welfare to supplement, or even outright replace, traditionally defined benefit pension schemes. These policies individualize risk and re-fashion individual citizens as long-term financial planners, navigating the uncertainty inherent in international financial markets and general financial management. Less deeply explored, however, are the perverse incentives this system creates for homeowners to protect their home “investment” by leveraging planning policies, zoning, and land-use restrictions to preserve the community status quo and lock in the value of their home. In a policy environment in which long-term financial risk is individualized and public social welfare and pension systems are relegated to the smallest number of individuals possible, this type of NIMBYism (Not in My Backyard) is rather rational behavior, even as it simultaneously staunches the supply of new housing and drives up prices for non-homeowners. As such, this analysis synthesizes the existing research to make a formal theoretical connection between the neoliberal push for commodified housing, asset-based welfare, and the intractable political problem of NIMBYism.

Impact of the choice of risk assessment time horizons on defined benefit pension schemes

AbstractWe examine the impact of asset allocation and contribution rates on the risk of defined benefit (DB) pension schemes, using both a run-off and a shorter 3-year time horizon. Using the 3-year horizon, which is typically preferred by regulators, a high bond allocation reduces the spread of the distribution of surplus. However, this result is reversed when examined on a run-off basis. Furthermore, under both the 3-year horizon and the run-off, the higher bond allocation reduces the median level of surplus. Pressure on the affordability of DB schemes has led to widespread implementation of the so-called de-risking strategies, such as moving away from predominantly equity investments to greater bond investments. If the incentives produced by shorter term risk assessments are contributing to this shift, they might be harming the long-term financial health of the schemes. Contribution rates have relatively lower impact on the risk.

What determines the asset allocation of defined benefit pension funds?

ABSTRACT The asset allocation decision is one of the most important decisions made by defined benefit pension schemes, with a major effect on the scheme contribution rate, funding ratio and financial position of the sponsoring company. We investigate the determinants of the equity allocation of UK pension funds using a panel of 1,304 observations on 125 companies that were members of the FTSE 100 over the 2003–2019 period. We find that seven variables have a significant effect on the allocation between equities and bonds – maturity (as measured by the effective duration of scheme liabilities), default risk, leverage of the sponsor, size of the sponsor (or the scheme), whether the scheme is closed to future contributions, whether the scheme has significant overseas liabilities, and a time trend. Our sensitivity analysis finds that the biggest effects on the asset allocation come from scheme maturity, the scheme’s funding ratio and a time trend.

What Determines the Freezing of Defined-Benefit Pension Schemes: Evidence from the UK

Given the shifting corporate policy from defined benefit (DB) to defined contribution (DC) schemes, we investigate the determinants of so-called ‘freezing’ of DB schemes. We test the reasons of pension freezing and its influence on firm performance, for all FTSE350 companies from 2009 to 2017. We find that pension plan asset is the key factor for determining the freezing of the DB plans and companies tend to close their DB scheme under a good economic state.

Executive pensions and the pay–performance relation—Evidence from changes to pension legislation in the UK

Abstract This article evaluates the role of executive pensions in the relationship between executive compensation and corporate performance. As a natural experiment, we exploit a major change to the tax-free allowances governing executive pensions. This reform affected the cost of pensions for firms whose executives had accumulated pension benefits in excess of the prescribed limit. We find a strong reaction to the reform. After 6 April 2006, many executives saw their defined benefit pension schemes replaced with risk-free cash payments. This imposition of an exogenous constraint on the contracting over CEO pay significantly decreased the relationship between executive pay and firm performance.

What Determines the Asset Allocation of UK Defined Benefit Pension Funds?

The asset allocation decision is one of the most important decisions made by defined benefit pension schemes, with a major effect on the scheme contribution rate, funding ratio and financial position of the sponsoring company. We investigate the determinants of the equity allocation of UK pension funds using a panel of 1,304 observations on 125 companies that were members of the FTSE 100 over the 2003-2019 period. We find that seven variables have a significant effect on the allocation between equities and bonds – maturity (as measured by the effective duration of scheme liabilities), default risk, leverage of the sponsor, size of the sponsor (or the scheme), whether the scheme is closed to future contributions, whether the scheme has significant overseas liabilities, and a time trend. Our sensitivity analysis finds that the biggest effects on the asset allocation come from scheme maturity, the scheme’s funding ratio and a time trend.

Risk shifting and the decline of defined benefit pension schemes in Australia

ABSTRACTRecent studies of private pension provision have stressed the shedding of risk by employers entailed in the international trend away from defined benefit to defined contribution arrangements. In this critical literature, the widespread development towards defined contribution schemes is seen as an exclusively poor outcome for employees as financial risk is pushed onto the members of pension plans. These criticisms have essentially been ahistorical – they are not founded in close analyses of the reforms of the relevant pension arrangements. The first country to undertake a major change from defined benefit (or benefit promise) to defined contribution (or accumulation) plans was Australia. A closer historical examination of the shift suggests that the considerable reforms in occupational pension schemes of the 1980s and 1990s cannot validly be seen, overall, as a regressive outcome for Australian workers. Three fundamental features of the reform of white-collar superannuation emerge from a close historical analysis. First, considerable simplification transpired in what previously had been a largely opaque system of retirement benefits provision. Second, there was a fixing of employer costs in light of the adoption of accrual accounting and an increasing drain on taxpayer funds in public sector schemes. Third, clear evidence of improved financial performance occurred during the reforms.

The Adverse and Beneficial Effects of Front-Loaded Pension Contributions

In funded defined benefit pension schemes, contribution and accrual rates are typically age-independent. This implies that pension contributions are front-loaded. As contributions and accruals usually relate to earned labor income, this front-loading may affect labor market efficiency. For it implies that the labor supply of younger workers is implicitly taxed and that of older workers implicitly subsidized. This paper shows that front-loading of pension contributions may be welfare-reducing. It also shows that the welfare loss is weakened if one accounts for government spending that is financed with a labor income tax. In this case, front-loading may even be welfare-increasing. In particular, the more elastic is the labor supply of older workers relative to that of younger workers, the more likely it is that front-loading produces a welfare gain.

THE BEGINNINGS OF MODERN COLLECTIVE OCCUPATIONAL PENSIONS IN BUSINESS IN SCANDINAVIA, CA. 1900–1930

The first three decades of the 20th century marked the beginning of modern collective occupational pensions for salaried business employees in the three Scandinavian countries. Pension premiums were derived from actuarial principles and pension entitlement was financially and legally secured. Relatively few salaried business employees were covered by these new occupational pension schemes until the 1930s. There were similar developments as well as different outcomes in the three countries. In their first three decades, the relative success of such schemes, and the participation of salaried employees in them, seems to have been largest in Denmark and lowest – as well as starting latest – in Norway. The development of occupational pensions in business is compared with Britain and Switzerland as well as with occupational pensions for public employees in the Scandinavian countries; the latter clearly functioning as a model. The new principles for occupational pensions in business, established during and after World War I, proved long lasting and increasingly important. In Norway, defined benefit pension schemes that started in business during World War I were not replaced by defined contribution pension schemes until after 2000.

Valuation of defined benefit pension schemes in IAS 19 employee benefits - true and fair?

PurposeThis paper aims to argue that the accounting standards’ requirements for the valuation of defined benefit pension schemes in the financial statements of scheme sponsoring companies potentially produce an artificial result which is at odds with the “faithful representation” and “relevance” objectives of these standards.Design/methodology/approachThe approach is a theoretical analysis of the relevant reporting standards with the use of a practical example to demonstrate the impact where trustees adopt a hedged approach to portfolio investment.FindingsWhere a pension fund engages in asset liability matching and invests in “risk-free” assets, the term, quantity and duration/maturity of which is intended to match some or all of its scheme liabilities, the required accounting treatment potentially results in the sponsoring company’s financial statements reporting fluctuating surpluses or deficits each year which are potentially ill informed and misleading.Originality/valuePension scheme surpluses or deficits reported in the financial statements of listed companies are potentially very significant numbers; however, the dangers posed by theoretical nature of the calculation have largely gone unreported.

Funding defined benefit pension schemes: an integrated risk management approach

This abstract relates to the following paper: Cowling, C. A., Fisher, H. J., Powe, K. J., Sheth, J. P. and Wright, M. M. (2019) Funding defined benefit pension schemes: An integrated risk management approach. British Actuarial Journal, Cambridge University Press, 24. doi: 10.1017/S135732171800034X .

Funding Defined Benefit pension schemes: an integrated risk management approach

Abstract The last 12 years have seen the evolution of a new funding regime under the supervision of the Pensions Regulator. Over this period, there has been significant turbulence in financial markets, including record low interest rates. This paper takes a critical look at the development of funding approaches and methodologies over this period. It analyses the Pensions Regulator guidance and how scheme specific actuarial methods have emerged since the move away from the Minimum Funding Requirement in 2001 and the introduction of the Scheme Specific Funding Requirements in 2005. It asks whether these new methodologies have been successful from the perspective of members, trustees, employers and shareholders. At a time when actuarial valuation methodologies have faced considerable criticism, this paper aims to propose a pension funding methodology which is fit for purpose and also reflects the latest guidance from the Pensions Regulator on integrated risk management.

Apples and Oranges: A Comparison of the Key Features of the Legislative and Regulatory Framework for UK and Dutch Defined Benefit Pension Schemes (Including Dutch CDC Schemes)

The UK and the Netherlands have different legal and regulatory regimes for defined benefit pension schemes. This paper compares and contrasts the key features of those regimes. The UK allocates all of the underfunding risk in a UK defined benefit pension scheme to the employer, backed up by the Pension Protection Fund in the event of the insolvency of the employer. In the Netherlands, the risk of an underfunding in a defined benefit scheme or CDC Scheme is shared amongst the members. There is no Pension Protection Fund. However, the funding standards in the Netherlands are prescriptive (in part because a Dutch pension fund is treated as a “regulatory own fund” for the purposes of Article 17 of the IORP I Directive (Directive 2003/41/EC)). The length of time for making good a deficit is prescribed with the benefits having to be reduced if the deficit is not made good to the required minimum funding standard within 5 years. In the UK defined benefit pension schemes are not regulatory own funds. Funding standards are based on “prudence” and account is taken of support of the employer (the “employer covenant”). Furthermore, there is considerable flexibility in the period over which a deficit in a UK defined benefit pension scheme is to be made good.

Growing Pension Deficits and the Expenditure Decisions of UK Companies

Large deficits have opened up on defined benefit pension schemes in the United Kingdom since 2007, and at the same time investment expenditure has been subdued; this is a common phenomenon in other countries too. We use privileged access to a unique new data set from The Pensions Regulator and two identification schemes to investigate the effects of deficits and deficit recovery plans on UK companies’ dividends, investment, wages and cash holdings. Identification is based on the close relationship between low long-term interest rates and pension deficits; and the external regulation of pension schemes by The Pensions Regulator. We show that firms with larger pension deficits voluntarily pay lower dividends, but they do not invest less. However, firms that are required to make deficit recovery contributions by the regulator have lower dividend and investment expenditure compared to other firms, and more so if they are financially constrained. These effects are large for some individual companies, but macroeconomically small compared to the stimulus offered by the Bank of England’s quantitative easing policy.

Integrated risk management for defined benefit pension schemes: a practical guide

AbstractThe Working Party has developed some practical hints and tips for those developing integrated risk management (IRM) plans for UK defined benefit pension schemes in the context of the requirements of the Pensions Regulator. Four case studies are presented to illustrate its conclusions, which are encapsulated in the ten commandments for effective IRM. IRM is the consideration of investment, funding and covenant issues, and how these interact. Its purpose should be to aid decision making and so should have a clear outcome in mind. It should be a continuous process and should form part of everyday trustee governance – it is not simply a one-off exercise. Whilst most Trustees and advisors consider funding issues when setting their investment strategy and vice versa, fewer fully integrate covenant into their decision-making process. However, covenant underpins all risk taken in a pension scheme and so needs to form a regular part of trustee discussions and analysis by advisors.