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Finance, coronavirus, the economy, etc (Read 58793 times)

stone

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Yes I think the BOE should have leaned very heavily on the Pension Regulator and anyway the Pension Regulator should have themselves stopped this.

Firms with Defined Benefit Schemes wanted the swaps not to serve those on the pension schemes but to make their owe company accounts look rosier to the firms' shareholders and creditors. The accounting rules mean that company accounts need to have the Defined Benefit Scheme as a liability valued as though it were a series of gilts able to fund those future pensions. So when interest rates are very low, a tiny further fall in gilt yields results in a huge increase in that notional present value of the pension fund liability (even though it has no material effect on whether the pensions can be paid by a sensibly managed fund).

If the sponsors wanted their accounts to be hedged against that, that is something they should be paying for, not something the pensioners on their scheme should be exposed to. They could for instance have hedged using options instead of swaps. Then there would have been no risk of calamity and merely an ongoing cost drag to the sponsoring firm.

Stepping back, the most sensible (IMO) way to avoid all the mess would be to change the accounting rules such that defined benefit pension liabilities on company accounts instead got a notional present value based on a sensible conservative view of what a well managed scheme yields. So say 3.5%/year over inflation.


« Last Edit: May 28, 2024, 10:29:35 am by stone »

Stabbsy

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That’s certainly one perspective, but IMO it’s a simplistic one that ignores a lot of the nuances around the way that the relationship between scheme, trustees and sponsors work in practice. Needless to say, I disagree with your viewpoint.

I’d also love to see your workings/evidence for how a mature scheme with liabilities in payment can earn yields of 3.5% above inflation, particularly in the current economic/regulatory environment.

I’ll try and find some more time for a more reasoned response later, but your argument of earning the yields required is contradictory to your restriction on investment freedoms that you want to put in place.

Oldmanmatt

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Yes, it’s not the optimistic climate that the media portray.
I have had two false starts over the last 18 months. One of which I had a signed contract for, passed my start date (without getting instruction on where to attend on that date, even though I had been promised the same on on the Friday before my Monday start) only to be told on the Tuesday afternoon that it was all postponed. Start rearranged for September (last), only to be told the whole project was to be kicked in to a September spending review, mid June. Each delay, ultimately, down to Covid, as rates surged and Gov departments retreated to home working again or issues around “isolation prior to deployment” became too tricky for Civvie contractors.

It’s been far more stressful and financially difficult than that sounds, as I had to withdraw from my other income source, prior to the first start date and have basically been unemployed for 12 months.

Our business (the climbing gym) has been massively impacted by it all. Our biggest income stream had always been schools, youth groups, clubs and parties (not climbers, there aren’t enough of us. Those kids parties you hate so much, subsidise your training). That’s only now and slowly, beginning to recover and we’ve had to cover shortfalls from the little we’d put away for a rainy day (actually it’s quite damp, really. Bloke down the road is building a big boat in his garden. I think his name is Noah, or similar).

Almost all the Government “support” went to Landlord and Utility companies and, since neither of us had ever drawn a wage, we couldn’t furlough ourselves (actually, we never even took a dividend. Still the only money we take out is “loan repayment” on our original investment and we haven’t been able to do that since Feb ‘20).

Basically, life sucks in a great many ways and Covid can do one (with an exceptionally large, spiky, dildo, coated in chilli). My patience with anti-vax morons and idiots that cry over facemasks and social distancing, is at the point where I would like to see the same dildos deployed in those quarters, too.

Add to that the more “Brexity” shite and it’s even more grating. Under the circumstances, running our van (the only thing all six of us can travel in together) is all but impossible. Even a half hour trip up to the Moors, to climb or whatever, is a once a month luxury now (we can’t budget more than £25/30 a week for fuel. Last Friday, £25 bought me 16ltrs of fuel).
As for shopping for a family of six, where the “children” are now almost as big as I am, wear adult clothes and shoes and eat adult portions? Fuck my life!

To be clear, prior to the Pandemic, we were secure, not flush, but pretty comfortable. The business gave some extras, it wasn’t essential. We’ve gone from ok, to unable to cover basic needs, even though our income hasn’t significantly diminished.
Both of us have managed to secure new employment and we both started this month, so, in theory, next month should be better. That hasn’t been as easy as it sounds, of course and I can strongly sympathise with Toby. This isn’t a sellers market, regardless of the hype in the Press. We’re both lucky to have unique skill sets, that by chance, play well into the current state of the world (which seems pretty wild and not simply because of Pandemics and Brexit. They just seem to compounding negatives for the UK. We as a nation, have shit timing).

Ok. Bit of a rant. But I’ve been sitting on it without being able to vent for months (and it feels like the above mentioned dildo).
I am certain, that all around me, people are more bad tempered, less tolerant and generally unhappy. Everyone I speak to, is struggling financially. I know many people who have lost jobs, though most seem to have found alternatives, if “lower” than their expectations. Quite a few of my friends have taken contracts in the Middle East, this year, to get away from their woes here (all Engineers).

Off the exact current topic, but scrolled back too far and stumbled on my post of Nov 21, which seems like yesterday.
I’d forgotten how low I’d got. Covid took more of a toll on me than it did my business (the climbing wall) and I have never once tested positive for the damn thing, nor been ill in anyway (despite at one point caring for the other five members of my family all positive and quite ill). A few months after this post, Covid swept through the ship I was on, confining the crew one by one to their cabins as they succumbed and at one point felling a woman I’d been dancing with (Patrick Swayze, very close, in arms style) 12 hours before she started showing symptoms.
And, bugger me if I didn’t end up taking a contract in the Middle East too, all of my friends are still here to boot.

As you were.

stone

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I’d also love to see your workings/evidence for how a mature scheme with liabilities in payment can earn yields of 3.5% above inflation, particularly in the current economic/regulatory environment.
I was basing it partly on reading this https://portfoliocharts.com/2024/04/01/what-global-withdrawal-rates-teach-us-about-ideal-retirement-portfolios/
and partly on the Wellcome Trust portfolio performance and future planning https://wellcome.org/reports/wellcome-annual-report

I'm interested in your perspective on all of this since you give the impression of being a lot more knowledgable than me!

AJM

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Yes I think the BOE should have leaned very heavily on the Pension Regulator and anyway the Pension Regulator should have themselves stopped this.

Firms with Defined Benefit Schemes wanted the swaps not to serve those on the pension schemes but to make their owe company accounts look rosier to the firms' shareholders and creditors. The accounting rules mean that company accounts need to have the Defined Benefit Scheme as a liability valued as though it were a series of gilts able to fund those future pensions. So when interest rates are very low, a tiny further fall in gilt yields results in a huge increase in that notional present value of the pension fund liability (even though it has no material effect on whether the pensions can be paid by a sensibly managed fund).

If the sponsors wanted their accounts to be hedged against that, that is something they should be paying for, not something the pensioners on their scheme should be exposed to. They could for instance have hedged using options instead of swaps. Then there would have been no risk of calamity and merely an ongoing cost drag to the sponsoring firm.

Stepping back, the most sensible (IMO) way to avoid all the mess would be to change the accounting rules such that defined benefit pension liabilities on company accounts instead got a notional present value based on a sensible conservative view of what a well managed scheme yields. So say 3.5%/year over inflation.

A few thoughts:
- the basis on which pension schemes appears on the company balance sheet (which incidentally is based on bond yields rather than gilt yields) is not in my experience the basis on which the scheme is usually managed. So those swaps and so on have not been bought to benefit the sponsors balance sheet.
- as Stabbsy suggests, it's worth making sure you understand why schemes might want to use swaps in managing the schemes interest rate exposure, rather than gilts, before assuming that banning schemes from using swaps would be a net improvement. It isn't a thing that would happen in isolation with no consequences further down the line.
- whilst I wouldn't argue that pension scheme valuation always gives meaningful answers, the way it behaves is trying to impart information. So when you say "when interest rates are very low, a tiny further fall in gilt yields results in a huge increase in that notional present value of the pension fund liability (even though it has no material effect on whether the pensions can be paid by a sensibly managed fund)" - if the scheme as a whole (i.e. considering the assets as well as the liabilities) looks worse in a lower interest rate environment, that is meaningful information, not just an abstract artefact of the calculation.

stone

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The actual assets in a sensibly managed fund might be yielding say 4%/year before and after any change in gilt yields from eg 0.5%/year to 0.25%/year. There is perhaps a chance they change from 4%/year to 3.75%/year. Either way it makes no difference to actually paying the pensioners in the future. But it makes a vast change to a present value liability calculation based on those gilt yields.

Consider a typical pension liability that the USS fund is faced with. That would be someone getting a three year fixed term job between the ages of 22 and 25. I suppose they would then be expected to draw a pension when they are 67 until 90 or something. The change in that liability present value from a 0.5% gilt yield to a 0.25% gilt yield is bonkers IMO.

Anyway, for the time being this is mostly of (recent) historical interest since gilt yields are now 4%.

AJM

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You won't get a sensible comparison if you allow for the impact of interest rates on the liabilities but ignore its effect on the assets (the change in the market value of a 50 year gilt when gilt rates fall from 0.5% to 0.25% is equally bonkers, given the maths works in the same way for both).

It's a good way to end up concluding that the whole thing is nonsense, which is fine if that's all you want to get out of it, but it isn't a comparison that makes any sense from a technical perspective.

stone

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The whole point as far as I could see is that the sensibly managed pension funds would not consist of 50year gilts at 0.25% yield. They would consist of an asset mix that would see little or no change in asset value when gilt yields fell from 0.5% to 0.25%. Meanwhile the liabilities would get a bonkers increase in value. To try and bridge that disparity, they entered into these swap contracts. Those swap contracts were what caused them such problems when gilt yields went in the other direction from 0.25% (or whatever they were) to 5% or whatever.

AJM

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It's difficult for this not to become quite technical quite quickly, but at a very simple level a large disconnect between asset and liability behaviour tends to point to a risk the scheme is exposed to.

So where you say "the sensibly managed pension funds would not consist of 50year gilts at 0.25% yield" - that's not necessarily the case. The benefit of that sort of investment strategy is that all your guaranteed outflows would be funded by guaranteed inflows, which leaves the scheme with very little residual risk and very little chance of needing to make sudden cash calls on a sponsoring employer.

Many schemes would love to be funded on a low risk or self sufficiency basis (the fine detail of pensions regulation is not my precise field, but I think it's an expectation from the pensions regulator for mature schemes?). Either this, or a buy out (transfer of the liabilities to an insurance company). And when pension schemes transfer their liabilities to insurance companies (which again has attraction for many schemes because of the certainty it provides), insurance companies will look to fund all the outflow from some sort of gilt, corporate bond or similar assets.

Where schemes aren't funded on this basis, again very simplistically you could say it's because they need to earn a higher return than that strategy can provide (or, equivalently, they don't have enough money to fund everything from low risk assets) and so are having to take more risk in order to do so.

 

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