September 20, 2021
With the Social Housing Pension Scheme (SHPS) 30 September 2020 actuarial results, employers who have closed their membership are favoured over open-to-new-entrants employers, argues Derek Benstead. How can SHPS Trustees offer a more equitable arrangement, and what can open employers do? The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of First Actuarial.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of First Actuarial.
When I first started working with housing associations over a decade ago, the majority of employees were earning a good Defined Benefit (DB) pension. In 2009, around 25,000 employees in the sector were earning valuable DB benefits in the Social Housing Pension Scheme (SHPS). That number is now less than 5,000, and is expected to go down even more in the coming months.
It seems to me that SHPS is no longer a scheme that serves employers keen to continue offering a DB pension for their employees. But does it really have to be that way? I don’t think so.
The 30 September 2020 actuarial valuation results
The SHPS actuarial valuation results are out, and the contribution rates for benefit accrual are massively up. Again. This is one of several ways in which the interests of employers whose membership is open to new entrants are being sacrificed in favour of employers who have closed their membership.
This need not be the case – the SHPS Trustee could amend its approach so open employers don’t suffer. In the absence of that outcome, however, open employers should seriously reconsider whether it’s tenable to continue with accrual in SHPS.
The interests of open and closed employers are in conflict
Years ago, most employers in the SHPS had employees accruing DB pension and were open to new entrants. When employers are similar to each other, an industry-wide pension scheme can serve all its employers, with roughly acceptable cross-subsidies between them.
Over time, changes within the SHPS have mirrored the trajectory of the pension industry as a whole. Employers whose DB membership of SHPS is open to new entrants are now in the minority. The majority of employers have either closed to new entrants or closed to accrual entirely. This has resulted in a conflict of interest between employers whose DB memberships are open to new entrants and employers who have closed their DB membership.
The respective circumstances of open pension schemes and closed pension schemes are fundamentally different. A closed scheme is running down, so the benefit outgo may exceed contribution and asset income, requiring realisation of assets to pay benefits. The investment time horizon is finite and shortening all the time, increasingly limiting the scope to make rewarding investments. And there has to be an eye on an end game, which may involve an insurance buy-out or consolidation.
In a prudently funded open scheme, on the other hand, contribution and asset income is likely to be in excess of benefit payments, if the active membership has not greatly shrunk. The investment time horizon is long, opening up the scope to make rewarding investments, which will pay for benefits and keep contributions down. An open scheme may have funding in place for the day it eventually closes, but while it’s open, it can and should invest appropriately for an open scheme.
The Pensions Regulator, in its thinking about the long-term funding targets, has addressed this. The Regulator has proposed that maturing schemes should work towards a high degree of independence from their employers, and that funding and investment strategies should recognise this. But the Regulator also recognises that an open scheme may not be maturing, and therefore need not move down the path to independence until increasing maturity indicates that it should.
This gives the SHPS Trustee a fundamental problem. The SHPS funding and investment strategies are suitable for a maturing scheme, and that makes them unsuitable for an employer open to new entrants.
Open employers make a greater contribution to prudence
The regulation of private sector pension schemes is required to be prudent. This is generally interpreted as having more than money than is expected to be needed to pay the benefits, to be on the safe side. It’s helpful to think separately about the best-estimate cost of providing benefits – which is what we expect to happen – and the prudent additional funding above best-estimate.
There are two ways to add to the prudent additional funding – deficit contributions and contributions for future service in excess of the best-estimate cost. All employers pay deficit contributions, but only those employers still accruing benefits make contributions in excess of the best-estimate cost of those benefits. Open employers, then, are making bigger contributions to prudent funding than closed employers.
Employers auto-enrolling into DB are overpaying most for benefit accrual
Different employers have different entry strategies. Some open employers may auto-enrol into a Defined Contribution (DC) scheme, with SHPS DB being an additional option for employees. Such a policy is likely to result in fewer entrants to SHPS DB and an older active membership. Other open employers may auto-enrol into a SHPS DB section. These employers are likely to have younger active memberships, and will be overpaying the most for their benefit accrual.
The allocation of deficit contributions is unfair to open employers
Up to and including the 2014 SHPS valuation, every increase in deficit contributions was identified separately, building up to four layers of deficit contributions, each with their own expiry date.
The first two layers of deficit contributions were expressed as a percentage of active members’ salaries, but this policy ceased to be tenable as an increasing number of employers closed to new entrants or closed to accrual. The third and fourth layers of deficit contributions were divided in proportion to an employer’s liabilities.
After the 2017 valuation, the original percentage of salary deficit contributions was abolished and replaced with deficit contributions in proportion to liabilities. This caused a noticeable change of deficit contributions for some employers (typically those who had been in SHPS for a long time). Also, after the 2017 valuation, instead of adding a fifth layer of deficit contributions, the layers were merged into one and divided in proportion to accrued liabilities. This caused a noticeable increase in deficit contributions for those employers who had been in SHPS for less time. Yet employers who have been in SHPS for the least time have paid most for their benefit accrual.
The introduction of a single stream of deficit contributions is unfortunate for open employers. Because they’re open to accrual, the additional liability attracts deficit contributions away from closed employers. Even if everything had gone as expected between the 2017 and 2020 valuations, the share of deficit contributions picked up by open employers would still have increased and the share of deficit contributions paid by closed employers would have decreased. Yet in the meantime, the open employers will have paid a prudent (i.e. more than enough) contribution for their accruing benefits.
Bad news for open employers
The 2020 valuation results are bad news for open employers. Their contribution rates for accruing benefits have increased greatly, and they are paying for:
- An investment strategy which is more cautious than warranted for open employers
- High contribution rates for accruing benefits, partly due to excess caution in the investment strategy and partly due to prudence in the discount rate, which affects younger members more
- A method of setting deficit contributions which attracts deficit contributions away from closed employers.
What can the SHPS Trustee do?
Planning within SHPS could be divided into two: one part for closed and closed-to-new-entrants employers, the other part for open-to-new-entrants employers. The latter could have a funding and investment strategy of its own, more suited to open employers. This would eliminate the cross-subsidy from open to closed employers.
A formal division of SHPS into two would be a complex project, but I don’t think this is necessary or desirable. The SHPS Trustees could think separately about funding and investment strategies for open and closed employers. They could also consider best-estimate costs and additional prudent funding separately. The signed-off SHPS valuation (and investment strategy) would be the sum of the two parts.
What can open employers do if the management of SHPS is not reformed?
If big enough to justify it, open employers can bulk transfer out of SHPS into their own scheme, and continue to accrue benefits in a scheme in which the funding and investment strategies are suitable for them.
Otherwise, open employers need to consider carefully whether continuing to accrue benefits in a scheme that doesn’t serve the interests of open employers is the right thing to do.
The views and opinions expressed in this article are those of the author, and do not necessarily reflect the official policy or position of First Actuarial.