Pensions Support Index 2017

Don’t bet on your defined benefit

Our Pensions Support Index measures the ability of companies in the FTSE 350 to support their defined benefit promise.

Biggest annual fall since the recession

2016’s political surprises have taken their toll on UK defined benefit pensions. Whilst corporate performance has been respectable (particularly for overseas revenues benefiting from weak sterling), the rush for safe assets has pushed gilt prices up and yields down, hitting the valuation of defined benefit liabilities very hard.

The fall in gilt yields has resulted in the Index falling by more than 10 percentage points, the biggest annual fall since the recession. The Pensions Regulator has highlighted this stress on defined benefit pensions – estimating 5% of schemes in this valuation cycle are at risk of, or already failing to, meet obligations.

Watch our short video where Jonathon Land, Pensions Credit Advisory Leader, Andrew Sentance, Senior Economic Adviser and Sinead Leahy, Pensions Investment Partner discuss the findings from the Pensions Support Index and economic climate.

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                                As schemes start to mature, the persistent low yield environment leads to vital questions:

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How to balance risk with returns

With gilt yields being the primary driver of the fall in the Index, hedging interest rate risk remains a key concern. But as schemes continue to mature, attention is increasingly turning to meeting scheme cash flow obligations – both transfers out and pensions in payment.

There is a desire by many to understand the risk of negative cash flows and the likelihood of becoming a forced seller of assets to pay liabilities. The fall in yields of traditional matching assets has opened up appetite for “Matching Plus” assets that hedge risk but also provide a better return, particularly as schemes approach maturity.

“Schemes that continue to wait for yields to rise are running a dangerous strategy if they can’t handle the downside risk. Many are now facing the difficult question of when not if their schemes will become cash flow negative. Schemes should consider having a proportion of matching plus assets.”
Sinead Leahy, Pensions Investment Partner

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Are people moving away from gilts-plus valuations?

The Pensions Regulator’s Annual Funding Statement notes that “the current debate on the approach to discount rates focuses on whether historical relationships between gilt yields and returns on other asset classes still hold true for the future.“ As investment strategies broaden to encompass a variety of non-gilt long term matching asset classes, there can be an argument to consider an asset-led discount rate that better reflects the returns of the investment strategy.

“As schemes move towards more of a cash flow matching approach questions often arise as to the most appropriate way to value the liabilities for Scheme Funding. A discount rate that prudently reflects the expected return across all assets may prove a better fit in the context of the company’s covenant, appetite for risk and views on investment strategy."
Richard Cousins, Scheme Financing Leader

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Will rates stay lower for longer?

The tightening of US monetary policy last year marked a turning point in the post-financial crisis economic story. Whilst drastic changes aren’t expected, if the US can achieve gradual interest rate increases, it is likely that UK and Eurozone interest rates will increase with a time lag.

“Whilst the recent US interest rate increases represent a turning point in monetary policy, there is still a way to go before other major advanced economies follow. In the UK, pension schemes with strong employer covenants are more likely to be able to weather the current low interest rate environment. However, schemes with weaker covenants need to think seriously about the level of risk they can tolerate and devise contingency plans.”
Andrew Sentance, Senior Economic Adviser

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What’s next for the pensions space?

The ongoing evolution of the pensions market promises an interesting time ahead. The Pensions Regulator calculates that 5% of schemes in this funding cycle are at risk – which could represent thousands of members who can’t bet on their defined benefit playing out as they think. We anticipate the following to be key influences affecting the pensions market:

  • A tougher regulatory environment
  • An emphasis on Integrated Risk Management
  • Potential transition from Retail Price Index to Consumer Price Index
  • 'Gamification' and the impact of technology.

Contact us

Jonathon Land
Partner, Pensions Credit Advisory Leader
Tel: +44 (0)20 7212 8629
Email

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