Written evidence from Simon Willes LDI0066

Further comments on Draft Funding Code

I consider that the new draft Funding Code needs a very long hard think because it is based on a flawed “belief” system in three parts as follows:

• It is built on the “belief” that the fundamental objective of UK pensions regulation is to deliver an insured outcome for all DB members. Whilst in itself this may be an admirable principle it is based on the false premise that an insured outcome can actually be delivered for all members which simply is not true as there remain £3bn of DB liabilities and annual insurance capacity of only max £50 bn per annum. The sums simply don’t work which is why consolidation and Superfunds were provisionally developed to provide alternative additional safe-haven capacity to absorb the tail risk for individual DB members. Unfortunately the insurance industry and PRA have fought hard to stop this initiative, the PPF doesn’t like it as it doesn’t shift residual risk to insurers away from them, and tPR have not had the guts to support it properly in case they get blamed. The large actuarial consultancies are now making most of their money from insurance risk transfers so are less than eager to point this out.

• It is built on the “belief” that taking investment risk is a bad thing to be discouraged despite DB schemes being originally based on the tenet of building up investment return in order to fund benefits. The danger of the new draft funding code is that is will be used by regulators to further drive out any investment risk being taken further denuding the UK economy of future investment risk capital. DB schemes will be now “forced” into supposedly low volatility asset classes of gilts and credit at the expense of earning proper risk-based investment returns. DB schemes are being taken for a complete ride by investment consultants who used to have to deliver returns for their fees but now effectively do little but advise everyone to take less risk, earn less investment returns and delay scheme funding progress. Cynically you could argue this improves the longevity of DB investment consulting! HMG has been rather encouraging of the de-risking trend as it supports the index linked gilt market which has provided incredibly cheap public funding (pre current inflation). However ILG’s have earned DB pensioners negative returns. Investing in credit has previously been the domain of investment banks and hedge funds but credit has been right at the roots of several financial crises. In a downturn every asset moves towards a correlation of 1 and becomes volatile and illiquid and the idea that some asset classes are low risk quickly evaporates.

• It is built on the “belief” that assessing the longer-term employer covenant is pointless. Benefit security in DB schemes primarily depends on the employer covenant. The draft Funding Code started off recognising this but has since gone 360 degrees and is heading towards adopting a new regime for assessing covenant largely driven by what the PPF thinks and wants. The recent independent review of the PPF was conducted by a regulatory insider and did not get close to examining whether the changing population of remaining DB will challenge a levy based underpin for benefits. The PPF thinks that because it has singularly failed to predict short-term insolvency trends, or identify individual key insolvencies such as Carillion in advance, that assessing the longer-term employer covenant is a pointless exercise. This approach is wholly inconsistent with the whole basis of banking regulation and credit assessment developed over many years in the UK and all financial systems with corporate debt.

February 2023