MOST under 40s won’t know what a defined benefit (DB) pension plan is. They have been born too late. Not for them a secure income for life that increases each year, but an arguably riskier route to retirement income through a defined contribution scheme. The majority of DB schemes in the private sector are either closed to new members, or are in the process of closing down altogether. They have become too expensive – and for some are about to become even more so.
Employers are bearing the brunt of the economic, accounting and regulatory changes that have driven up the costs of DB schemes. And none more so than building societies. But it is not rising longevity, lower investment returns or increasing contributions that has caused the latest shock. It is good, old-fashioned bullheadedness.
Employers with a DB scheme must pay a levy to support the Pension Protection Fund (PPF) that steps in if a scheme is in trouble. That is 17,000 diverse employers and guarantors in the UK. The PPF offers protection to those working (and accruing pension) and those claiming a pension.
How the levy itself is calculated has changed and is now risk-based. So far, so good. The trouble is the risk assessment is designed to fit the “typical” DB scheme employer, one that has turnover based on sales and assets which you can see and touch. Your average manufacturing or retail business in other words. The “typical” scheme does not fit the banking model, particularly those in the mutual sector such as building societies.
Under the new insolvency risk-based calculation of the levy administered by Experian, employers add their data to one of eight differently-weighted scorecards. These scorecards then generate a band on which the levy is based. So every one of the 17,000 employers and guarantors must fit into one of eight scorecards. The templates on which employers submit accounting information are geared to the “typical” DB scheme employer. As such they do not recognise maturity transformation - taking short-term liabilities such as savings, and turning them into longer term assets such as residential mortgages - the underlying basis of banking businesses.
Trying to fit building societies’ accounts into the Experian scorecard system has led to inconsistencies and illogical and unfair bands. The scorecards do not, for example, capture a building society’s strength in capital and liquidity. This strength and resilience (especially under the tougher rules now in place since the banking crisis) is far higher than in manufacturing and service businesses. The fact that each and every building society could easily cover a scheme deficit without a material impact on its capital strength is not reflected in many societies’ bands.
And it is not just capital and liquidity regulation that building societies must comply with. Under the Bank Recovery and Resolution directive - a core piece of post-banking crisis regulation aimed at ending “too big to fail” situations and bank bail outs - building societies (and banks) are required to prepare and update at least annually a detailed recovery and resolution plan (also known as a “living will”). These plans outline how institutions would regain viability if they were under severe financial pressure and the steps national regulators would take if, despite these measures, the banks fail.
Under Experian, some building societies have ended up paying up to four times what they paid under the previous system. One saving grace is that the larger building societies are less affected. Experian's one-size-fits-all approach to insolvency risk assessment implies that some building societies are among the highest risk of failure of all defined benefit sponsors in the UK, which, given the protections described above, seems unlikely.
Building societies are not the only ones to have suffered under the new inflexible model. Trade associations and professional bodies have come a cropper. They too are not in the “typical” DB scheme employer mould so have had to be crowbarred into scorecards that don’t reflect how they do business. Building societies’ own trade body, the BSA, has seen its levy rise from £3,500 when it was in deficit to £20,000 – when it is in surplus. How can that be right?
At the start of this blog, I mentioned bullheadedness. I lay this accusation firmly at the door of the Pension Protection Fund (PPF). The PPF has inexplicably decided to keep things as they are. It has ruled out the sort of changes necessary to ensure building societies are rated on a fair, consistent, intellectually sound and risk-based approach. It has concluded that the Experian model is “fully transparent, [and is] easy to monitor, has been, and continues to be, welcomed” – even when that is patently not true. This means we are stuck with the current system for at least another year. We are not even after special treatment – we just think the PPF should do something now to allow low risk institutions like building societies to pay an appropriate amount. To try and fit each of the UK’s 17,000 DB employers into one of eight scorecards is over-optimistic to put it mildly. Businesses in the UK are far more diverse. It is a shame the PPF will not recognise this.