Investment for mature schemes
The London & SE Region of the
Occupational Pensioners' Alliance
February 2007
Simon Jagger MA FIA
Jagger & Associates Ltd
Structure of a typical mature scheme
• Usually closed to new members and to ongoing accrual –
i.e. deferreds and pensioners only
• “Active” deferred members may have salary linked
benefits
• Need to consider age-by-age reserves profile, and
associated matching asset allocations - duration of
liabilities will influence strategy
• Examine future cashflow pattern
• [Sample charts follow later]
• Consider how any strategy will evolve over time, and at
what speed, plus materiality
• Compare size of Scheme to financial size of sponsoring
employers - Trustee concerns over employer covenant
General Considerations
• Benefits go up broadly in line with RPI
• So do payments on index-linked Government Stocks
• So I-L gilts are a natural “match for these liabilities BUT –
the match is not perfect ….
• Inflation can (in theory) be negative (unlike pension
increases)
• Pension increases typically have a ceiling
• Index-linked gilts are not “long” enough, and too sparse at
longer dates
• Too many pension schemes want them, therefore very
expensive!
• Not a match for salary increases
Gilts and Corporate Bonds
13
12
11
10
9
8
7
%
6
5
4
3
2
1
0
Dec-85 Jun-88 Dec-90
Jun-93 Dec-95 Jun-98
Long bond yield
Sources:
Dec-00 Jun-03
Dec-05
ILG RY
Financial Times, Barclays Capital
400
350
300
250
200
150
100
50
0
-50
Dec-90
Dec-92
Dec-94
Non-Gilt
Dec-96
AAA
Dec-98
AA
Dec-00
A
Dec-02
BBB
Dec-04
Example Cashflow Projection
Cashflow (£k)
1,800
1,600
1,400
1,200
1,000
800
600
400
200
2005
2015
2025
2035
2045
2055
2065
Tim e
Active
Deferred
Pensioner
Total
• A typical closed scheme pattern
• Scheme Actuary will normally update data as part of valuation
NB – a generic scheme
Another cashflow example, this time
with ILG “matching”
180
160
140
120
100
80
60
40
20
0
2007
2017
2027
2037
Liability (£m)
2047
2057
2067
ILG
• Spikes are the years when the 11 ILGs mature
• Not much of a cashflow fit, so you have to realise a lot of capital as
you go along
NB – a generic scheme
Cashflow Projections
Assumptions
• Pension increases (RPI?)
• Salary increases where relevant (RPI+2%?)
• Mortality – much more a subject of debate now
Note that investment returns do not figure at this stage
% of liability
Example Liability Profile
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
23
33
43
53
63
Age next at April 2004
Active
NB – a generic scheme
Deferred
Pensioner
73
The Problem
Cashflows have to be met from:
• Investment proceeds, and/or
• Employer contributions
More of one means less from the other
• Can work out “required yield” from current fund (which is
where the investment return starts to enter the situation)
• Often very sensitive
Example Fund Projection
45,000
40,000
Fund size (£k)
35,000
30,000
25,000
20,000
15,000
10,000
5,000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
Year
5%
6.27%
• A mature scheme, almost at the contracting stage, and with a sizeable
FRS17 deficit
• Implied required investment return
NB – a generic scheme
The XYZ Pension Scheme
• If assets are sufficient on basis of gilt yields, why risk
failure by investing elsewhere? But there is still exposure
to mortality risk.
• Very few schemes are in the luxury of having this as an
option.
The XYZ Pension Scheme
• Most schemes rely on ongoing contributions from the
employer
• What investment return was assumed in calculating the
contributions?
• Does this force the trustees to look for higher returns?
• If not, do the trustees want to “help” the employer? (e.g.
charities or non-profit employers)
The XYZ Pension Scheme
What are the options?
•
•
•
•
•
•
•
Corporate Bonds
High Yield (sometimes still called junk bonds)
Property
UK Equities
Overseas Equities
Private Equity
Hedge Funds
Example Risk-Return Profile
6
OS equity
UK equity
5
Real Return (% p.a.)
Property
HY
4
Current
3
OS bonds
2
1
UK bonds
ILG
Cash
0
0
2
4
6
8
Risk (% p.a.)
NB – a generic scheme
10
12
14
Equity Risk Premium
7%
6%
5%
4%
3%
2%
1%
0%
-1%
-2%
Feb-97
Feb-99
Feb-01
UK prem
US prem
Feb-03
Feb-05
trigger
• Based on market and earnings levels, plus bond yields
• Want the result to be well above the “trigger” to justify holding
equities
Commercial Property
40
30
% Return
20
10
-
-10
-20
73
Sources:
78
83
88
93
98
03
IPD, UBS
• Long run of strong returns – too good to be true?
• Still a good income generator for many schemes
“Period to deficit payoff” analysis –
allowing for investment risk
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
0
5
10
15
20
25
• Little chance of eliminating deficit in the early years
• Initial peak is around the term used by the actuary, assuming no
investment risk
• Material risk that the deficit is still outstanding after 25 years
Conclusion
• You need to understand many things for a mature scheme
before you can begin to assess what the investment
strategy should be!
These include:
• The shape of a scheme, and how it is expected to evolve,
both in liability profile and cashflow terms
• The employer covenant, and scope for support via direct
contributions or other methods
• Make sure you focus on material aspects first!