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Does The UK Offer Answers For Multi-Employer Pension Reform?

Regular readers will know that, with respect to the multi-employer pension crisis, I’ve said repeatedly that a compromise solution is needed, and in January I proposed that a reasonable way to find middle ground in the seemingly-intractable question of how conservatively these plans should be funded in the future, is to “grandfather” in past accruals with past funding rules, and tighten requirements for future accruals. In the hopes that the ongoing discussions towards finding a solution have not been shut down but continue as suggested by reports, here’s a suggestion: look abroad for answers, or, at least, a reasonability check.

After all, way, way back when I first addressed the issue, I compared American Taft-Hartley multi-employer plans to their nearest counterpart in the Netherlands, which had recently made headlines for concerns about benefit cuts. While Americans law deems an 80% funded status on an “expected return” basis (7% or thereabouts) to be entirely satisfactory and in the “green zone,” Dutch plans are required to be 104% funded at a rate which, at the time was 1.5%, or face benefit cuts. (Remember, the lower the discount rate, the higher the liabilities and the greater the contributions needed to maintain full funding.)

Which brings me to the United Kingdom and another example of pension funding requirements. There, multiemployer plans are not union-based but may cover various employers in the same industry. Some examples are the Universities Superannuation Scheme (USS), Motor Industries Pension Plan (MIPP), Railways Pension Scheme (RPS), and Electricity Supply Pension Scheme (ESPS) — yes, in the UK a “pension plan” is called a “pension scheme” which is difficult to get used to when you’re used to “scheme” having a devious connotation. (There are also versions of “multiemployer plans” in which all liabilities and contributions are calculated separately, but the plan is administered as a single plan to cut costs; these exist in the U.S. under the label “multiple employer plans” which is admittedly confusing.)

So how are these plans funded? The short answer is “no differently than single-employer pension plans” — which, of course, used to be true in the U.S. as well until those requirements were tightened for single-employer plans but not multi’s in 2006. And the funding requirements for plans in the UK are different than the US in several crucial ways.

In the first place, a UK pension plan is a trust which is an entity that’s legally separate from the employer; Trustees represent the interests of plan participants and negotiate with the employer, with the intention to push for as securely-funded a plan as possible within the employer’s constraints: this means the assumptions used for the valuation and the contribution are both negotiated. Above this structure stands the UK Pensions Regulator, who doesn’t dictate a fixed set of requirements but oversees the process.

Now, superficially, this is not that different than the American Taft-Hartley structure, in which multi-employer plans are managed by a joint board with union and employer representation. But in the UK, the benefit level is taken as a given and the focus is maximizing the funding security; in the US, the benefit level is subject to intense negotiations and security of funding has tended to be taken for granted. What’s more, unions have a host of other concerns (and the Teamsters have been accused of sacrificing the financial health of the Central States plan for its wider objectives as a union), but pension trustees in the UK are solely concerned with the financial health of the pension plan.

But the second difference is even more important: pension plans (again, both single- and multi-employer) are required to fund on a basis of prudence, or conservatism, rather than merely best estimates. With respect to the debate about the discount rate plans should be required to use, this means, on average, a discount rate of around gilts, that is, government bonds (”gilt-edged”) + 0.7%. That means that right now, when American multi-employer plans average 7%, UK plans use a rate of, on average, 1.5% (based on current rates reported at Bloomberg). By comparison: for financial reporting, at 2018 year end, based on the Willis Towers Watson 2019 Global Survey of Accounting Assumptions for Defined Benefit Plans, the rate used for financial reporting was, on average, 2.74% in the UK and 4.3% in the US, based on corporate bonds. What’s more, the rate used to calculate expectations of asset return stood at 4.77% in the UK and 6.49% in the US; the rate in the US is greater both because of higher bond returns and because American companies have a greater proportion of their pension fund assets invested in equities.

Historically, this practice of using prudent assumptions has also meant that the UK was far ahead of the curve in terms of mortality tables; though we’ve caught up in the meantime, at a time when American actuaries were still using outdated tables and deeming them good enough, actuaries in the UK were projecting mortality improvements.

And whenever a plan is underfunded on the basis of these prudent assumptions (called the “Technical Provisions”), the plan must establish a “Recovery Plan,” to pay off deficits in something like 7 – 10 years. Each Recovery Plan is worked out with the Regulator and attempts to balance the desire for sufficient funding with the company’s financial circumstances. As in the US, if a plan does become insolvent, there is a government backstop, in this case called the Pension Protection Fund (PPF). Finally, there is an effort underway to create a new funding code with more specific expectations for employers starting in 2021.

Now, as it happens, these very conservative funding requirements had not always been in place; however, unlike the dramatic shift in 2006 for single-employer plans, and the one-time shift (with phase-in) being contemplated for multi-employer plans, the shift in the UK to a more conservative approach occurred incrementally, as the result of one Trustee/Employer negotiation after the next. For some plans which are closed so that an proportion of the participants who are retired increases gradually over time, there’s a further element of gradual implementation of a lower discount rate, with a higher rate used for workers and a lower rate for retirees; over time, the weighted average rate reduces.

So what’s to be learned here? On the one hand, conservative funding is entirely reasonable or, at any rate, not outlandish. And at the same time, the UK experience also points towards gradualness in making changes.

(Note: the unsourced information about UK pensions is courtesy an actuarial colleague to whom I express my appreciation.)

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