Explore answers to commonly asked questions about pensions.
Curious? Your questions answered
Some of the benefits of CDC for employers include:
Certainty on the costs to the scheme provided by fixed contribution rate with no risk of future deficits (as future indexation adjusted annually to balance the scheme).
Employers are free to choose contribution rates (subject to DC auto-enrolment requirements).
Support from trade unions, who have been closely involved in the development of CDC schemes.
The higher expected benefits provided by CDC are attractive to members. This could aid recruitment and retention and help with workforce management.
Several factors limit investment in productive finance, including externalities that are not fully reflected in returns, information gaps in which investors lack sufficient data or expertise, and coordination challenges in which action depends on multiple parties moving together. Regulatory and structural constraints can also restrict access, particularly for smaller schemes. Scale is important because larger schemes are generally better able to diversify, build specialist capability and access private markets on more efficient terms.
First produced in 2001 by Paul (now Lord) Myners, there are two sets of investment principles, one for defined benefit (DB) and one for defined contribution (DC) pension schemes. The original principles have since been modified. They are now known as the (2008) Myners Investment Principles for DB schemes and the Investment Governance Group Principles for DC schemes, each comprising six principles. They are designed to improve the overall level of UK institutional pension scheme governance, in particular with respect to investment decision making.
Key risks of run-on include:
Covenant: Conditions may change meaning the scheme sponsor becomes unable to support the scheme.
Longevity: Pension scheme members may live longer than expected leading to an increase in pension payments.
Investment: Asset returns may be lower than anticipated.
Regulatory: New policy and legal decisions could impact how schemes need to be run.
UK pension trustees that are required to produce a Statement of Investment Principles must set out their policy on voting rights and on how they monitor and engage with relevant persons, including issuers and asset managers. Where an implementation statement is required, trustees must explain how those stewardship policies have been followed, describe voting behaviour including the most significant votes, and state any use of a proxy voter.
The administrator of an investment fund is responsible for carrying out day to day administration. This includes activities such as calculating the fund’s Net Asset Value and preparing its accounts and maintaining its financial records.
This is the measure of the sensitivity of the value of an asset (such as a bond) or a liability (such as a pension scheme cash flow) to changes in interest rates. For example, an asset or liability with a duration of 10 is expected to rise (fall) in value by 10% following a 1% fall (rise) in interest rates. Pension schemes can reduce the sensitivity of their funding level (the value of assets held relative to the target value of assets) to changes in interest rates by purchasing assets of similar duration to the liabilities, a technique that underlies Liability Driven Investment (LDI).
This is an attempt to manage the risk of the fall in the value of one asset ('Asset A') by purchasing another offsetting asset ('Asset B'). The aim is for the value of Asset B to respond in an equal and opposite manner to Asset A to a given set of factors. For example, you could try to hedge the risk of wet weather if you own equity in an ice-cream company by buying equity in an umbrella company.
For a pension scheme, hedging is also used to refer to investment in assets which behave in the same or a similar way to liability cashflows in response to a range of economic factors – eg changes in interest rates and inflation – with the objective being to reduce both the likelihood and size of any divergence between the value of the scheme’s assets and its funding target.
Often offered as an option (and very often the default option) for defined contribution (DC) arrangements, lifestyle is a term-to-retirement dependent investment strategy. While retirement remains in the distant future, a member’s contributions are invested normally in a range of assets (eg equities) expected to deliver “real” returns (ie above inflation). In the run up to retirement, the member’s contributions are moved gradually into an appropriate mix of assets whose final allocation depends upon whether the member has chosen a drawdown, cash or annuity option.
Productive finance refers to investment in assets that support long-term economic activity, including infrastructure, private equity, venture capital, affordable housing and growing UK businesses.
Pension scheme trustees may choose to “buy-in” some of their scheme’s expected future benefit payments by purchasing a bulk (ie one covering many individuals) annuity contract with an insurance company. This allows the trustees to reduce their scheme’s risk by acquiring an asset (the annuity contract) whose cash flows are designed to meet ie “match” a specified set of benefit payments under the pension scheme. The contract is held by the trustees and responsibility for the benefit payments remains with the trustees. Common uses of buy-in arrangements have been to cover the payments associated with current pensioners or a subset of those members. Contracts to meet payments to members who are yet to become pensioners can also be purchased.
