In the third of a three-part series on the sustainability of pensions in the UK, Con Keating, head of research at Brighton Rock Group, discusses regulation
Numerous academic and practitioner studies have attributed the decline of the UK occupational defined benefit system to regulation and accounting. In this article we examine the magnitudes of some of these effects.
To start, with the effect of the abolition of advanced corporation tax (ACT) in 1997, (Figure 1) shows the Barclays Capital dividend index since 1954, with linear regressions on this equity income data. Three distinct regimes are evident (and supported by formal econometric testing) – the 1950/60s Ross-Goobey inspired rise of the cult of the equity – the post-1974 rise of banking and finance – and finally the post-ACT world.
The effect of the abolition of ACT should be a lowering of the growth or slope of the regression line – to, perhaps, as little as 78% of the previous rate. However, we observe a far greater decline. Had the index continued growing as previously, the dividend index would now be at some three times its current value; in fact, the dividend index is now growing at less than the 1950s rate.
Though companies are now increasingly returning capital through share buy-backs rather than dividends, these cannot account for the difference observed. Looking to the US, where buy-backs are the dominant means of distribution, the dividend growth rate has been broadly steady over the entire period. The abolition of ACT appears to have proved far more costly than the simple £67bn capital value estimate of the time.
Many actions have been taken by schemes to limit their costs and perceived risk exposures. The majority of UK DB schemes have closed to new members and many have closed to future accrual. The effect of these actions on ordinary contributions is perhaps surprising. Table 1 (below) shows the average contribution rates of open and closed schemes in 2008 and 2009.
We see that closing a scheme to new members raises the cost of provision of existing benefits by some 20% -25% or so. It is interesting that members are paying more of the total cost. It is also evident that these liability management manoeuvres will take a long time to be fully reflected in sponsor costs. These are rather ineffective forms of risk management, at least in the short-term.
Special contributions from sponsors have reached unprecedented levels – some 35% of ordinary contributions. Since the early 1990s, ordinary contribution costs to employers have risen five-fold, total contribution costs have risen eight-fold, and the difference is almost entirely due to the new regulatory regime. So the question really should be asked has this regime proved effective?
This question may be answered by examining the Pension Protection Fund’s deficit/surplus index which is shown below as Figure 2, and a linear regression on these surpluses and deficits.
It is alarming that, even with all of these liability management actions and the increases in contributions, the situation in late 2010 was no better than in mid 2003. The regression suggests that the situation is worsening marginally rather than improving, though the low explanatory power (R Squared) of the regression is comforting.
Risk management has come to the fore in scheme management and asset allocation. Liability driven investment is now almost mainstream. This would suggest that assets and liabilities should move together rather more now than in previous times, that the correlation of scheme asset to scheme liabilities changes should have increased. See Figure 3.
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