Should Defined Benefit Pension Schemes be Career Average or Final Salary?

There is widespread dissatisfaction amongst employers with defined benefit pension schemes, and many are switching to defined contribution schemes. Career average is a form of defined benefit scheme that has some important advantages over final salary schemes. The comparison of career average and final salary schemes is a neglected area, and this paper offers one of the first in-depth analyses of this topic. It considers the advantages and disadvantages of a cost neutral switch to a career average re-valued earnings (CARE) scheme.career average re-valued earnings (CARE) Pension schemes, final salary pension schemes, defined benefit pension schemes, redistribution

Merging Schemes: An Ecomomic Analysis of Defined Benefit Pension Scheme Merger Criteria

The conditions under which pension schemes merge is an important issue that has been under-researched. Mergers can affect the strength of the sponsor’s covenant and the balance of power between the trustees and the sponsor, as well as the scheme funding ratio. This paper sets out two financial criteria to be met by any pension scheme merger:- no profit or loss on merging with another scheme; and no dilution of the funding ratio. After defining a merger basis for valuing the assets and liabilities, and allowing for adjustments to the funding ratio via side receipts and payments; it is shown that, whether or not these criteria are met, depends on the state of the financial markets

Valuing Medieval Annuities: Were Corrodies Underpriced?

Medieval bishops condemned and restricted the sale of corrodies (a type of annuity), partly on the grounds of their perceived unprofitability. The available data on the profitability of corrodies is limited and little analysed, and the episcopal condemnation of corrodies has been adopted by modern researchers. After recognising the difficulties, this paper applies an annuity pricing model to study corrody pricing. Given various assumptions, contrary to the established view, it is argued that the sale of corrodies was financially profitable for institutions. Finally, some reasons are considered for the negative attitude of contemporary and historical opinion towards the sale of corrodies.Corrodies, pensions, annuities, monasteries, pricing models

Joined-Up Pensions Policy in the UK: An Asset-Libility Model for Simultaneously Determining the Asset Allocation and Contribution Rate

The trustees of funded defined benefit pension schemes must make two vital and inter-related decisions - setting the asset allocation and the contribution rate. While these decisions are usually taken separately, it is argued that they are intimately related and should be taken jointly. The objective of funded pension schemes is taken to be the minimization of both the mean and the variance of the contribution rate, where the asset allocation decision is designed to achieve this objective. This is done by splitting the problem into two main steps. First, the Markowitz mean-variance model is generalised to include three types of pension scheme liabilities (actives, deferreds and pensioners), and this model is used to generate the efficient set of asset allocations. Second, for each point on the risk-return efficient set of the asset-liability portfolio model, the mathematical model of Haberman (1992) is used to compute the corresponding mean and variance of the contribution rate and funding ratio. Since the Haberman model assumes that the discount rate for computing the present value of liabilities equals the investment return, it is generalised to avoid this restriction. This generalisation removes the trade-off between contribution rate risk and funding ratio risk for a fixed spread period. Pension schemes need to choose a spread period, and it is shown how this can be set to minimise the variance of the contribution rate. Finally, using the result that the funding ratio follows an inverted gamma distribution, shortfall risk and expected tail loss are computed for funding below the minimum funding requirement, and funding above the taxation limit. This model is then applied to one of the largest UK pension schemes - the Universities Superannuation Scheme

Trading death: the implications of annuity replication for the annuity puzzle, arbitrage, speculation and portfolios

Annuities are perceived as being illiquid financial instruments, and this has limited their attractiveness to consumers and their inclusion in financial models. However, short positions in annuities can be replicated using life insurance and debt, permitting long positions in annuities to be offset, or short annuity positions to be created. The implications of this result for the annuity puzzle, arbitrage between the annuity and life insurance markets, and speculation on expected longevity are investigated. It is argued that annuity replication could help reduce the annuity puzzle, improve the price efficiency of annuity markets and promote the inclusion of annuities in household portfolios

The implications of the COVID-19 pandemic for pensions

COVID-19 and the lockdowns have had a big global economic effect, as well as increasing mortality. We examine the effects of COVID-19 and the resulting relaxations of pension regulations on pension schemes. Those who transfer their pension or withdraw cash from their pension pot while asset prices are depressed by COVID-19 are losers; as are members of defined benefit schemes with a deficit whose employer fails due to COVID-19. The increased mortality from COVID-19 will have a minimal effect on pensions. If economies recover to pre-COVID-19 levels, the long run effects on pensions should be small

A False Perception? The relative riskiness of AIM and listed Stocks

This research examines the perception that the AIM market is riskier than the Official List market in comparable stocks. The empirical analysis uses high frequency data for January 2000 to December 2004 on 533 AIM stocks and 264 comparable Official List stocks. Risk is measured in a variety of ways. At a superficial level AIM stocks appear riskier than comparable Official List stocks. However, as the analysis is refined to ensure the comparison focuses purely on the effects of being listed on different markets, the additional AIM risk shrinks and finally disappears. This conclusion concurs with the current market practitioner view that there is no significant risk differential.

Pension scheme redesign and wealth redistribution between the members and sponsor: the USS rule change in October 2011

The redesign of defined benefit pension schemes usually results in a substantial redistribution of wealth between age cohorts of members, pensioners, and the sponsor. This is the first study to quantify the redistributive effects of a rule change by a real world scheme (the Universities Superannuation Scheme, USS) where the sponsor underwrites the pension promise. In October 2011 USS closed its final salary scheme to new members, opened a career average revalued earnings (CARE) section, and moved to ‘cap and share’ contribution rates. We find that the pre-October 2011 scheme was not viable in the long run, while the post-October 2011 scheme is probably viable in the long run, but faces medium term problems. In October 2011 future members of USS lost 65% of their pension wealth (or roughly £100,000 per head), equivalent to a reduction of roughly 11% in their total compensation, while those aged over 57 years lost almost nothing. The riskiness of the pension wealth of future members increased by a third, while the riskiness of the present value of the sponsor’s future contributions reduced by 10%. Finally, the sponsor’s wealth increased by about £32.5 billion, equivalent to a reduction of 26% in their pension costs

Conference Conversations: Monique Charles on Corbyn and Grime

Yesterday Renewal co-hosted an event with The Corbyn Effect at Momentum’s conference, The World Transformed, in Brighton. One of the speakers, Monique Charles, recently completed a PhD on grime music. In The Corbyn Effect she looks at the phenomenon of Grime for Corbyn, and we had coffee with her to talk about her work, Jeremy Corbyn, and the Labour Party