A new approach to how liabilities for pensioners in defined benefit schemes are funded could generate £40bn extra value, PwC has found, as responses are submitted to the Pension Regulator’s (TPR) ongoing consultation on future regulation.
TPR is in the midst of a consultation to review how it regulates the funding of UK defined benefit (DB) pension schemes. First-stage consultation responses were submitted earlier this month.
Analysis undertaken by PwC, the professional services firm, found the improved funding is possible through a more contemporary approach to how pensioner liabilities are financed and valued. The improvement would come from avoiding pensioner liabilities being too closely tied purely to gilt investments. Instead, the real need for pension schemes is to match the annual outgoing cashflows each year as they pay pensions. These commitments could be supported with a diversified portfolio of cashflow-matching bonds and other low-risk income-generating investments.
Raj Mody, global head of pensions at PwC, said:
“The pensions industry has been shoe-horned into an undue focus on referencing everything back to gilts, as a so-called risk-free benchmark. While that doesn’t stop individual schemes doing their own thing, the trouble with this kind of reference point is that it creates a herd mentality. This then puts pressure on trustees or companies looking to follow a more bespoke approach, even if it’s a better strategy for their own pension scheme.”
Over the last decade, pension scheme investment in gilts has doubled from 23% to 45% of their assets. The proportion of pension funds related to paying current pensioners is 40%. This shows that there is a drift towards using gilts, which partly comes from having rules and regulations framed around gilt yields. But analysis shows this is not necessarily the most optimal solution for every pension fund.
Raj Mody added:
“Even previous funding regimes have recognised the need to treat the funding of existing pensioner liabilities with caution. The Minimum Funding Requirement introduced in 1997 had a special concession for valuing large groups of pensioners. If anything, the need for something like this is now more acute. Pension schemes are now doing exactly what they exist for - to pay out retirement incomes. But that makes it all the more important to get the new funding framework right, both for existing and future pensioners.”
PwC advocates that the parameters underpinning any new funding regime are flexible enough to avoid a need for pension schemes to back their pensioner liabilities with gilts. Forward-looking parameters should focus on the cashflow obligations of pension funds, with flexibility to find the best assets to meet those cashflows, instead of focusing on a single-point valuation of the liabilities and comparing those to a single-point asset number. The extra value generated would benefit pension schemes, facilitating more diverse investment strategies.
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