Industry view – Society of Pension Professionals


Simon Daniel is deputy chair of the Society of Pension Professionals’ investment committee.


A DIFFERENT LANDSCAPE FOR UK DB SCHEMES


It has been 11 years since SPP published its Vision 2020 paper and, while it’s impossible to predict the future, the 2012 edition turned out to be quite prescient – at least in one respect. That concerned the observation that UK defined benefit (DB) schemes’ collective demand for index- linked gilts substantially outstripped the available domestic supply. This demand- supply imbalance led SPP to expect sus- tained upward pressure on index-linked gilt values, and corresponding downward pressure on yields, over the decade ahead (which proved right). Vision 2030 has been published at a rather different time for financial markets and UK DB schemes. With yields higher, many schemes’ funding positions have surged from deficit to surplus. Even on the most prudent bases, and trustees and corporate sponsors have been accelerated along their journey plans, finding them- selves ready to consider securing their scheme’s liabilities with an insurer. And so, as we look ahead to the next dec- ade for these schemes, and the challenges to navigate investing their £1trn+ of as-


sets, the importance of running a resilient portfolio which is able to withstand mar- ket dislocation has gained prominence. Accordingly, a key theme of the 2020 paper is also a key theme of the 2030 vin- tage – whether the way in which schemes manage their inflation exposure (through recalibrating their conventional and index-linked gilt holdings) is potentially susceptible to inflation expectations mov- ing in the opposite direction from their upward trajectory of the past 12 months. The explanation for the concern the paper identifies in relation to inflation is techni- cal, but boils down to the fact that, because schemes’ inflation-linked liabilities typi- cally carry a floor of zero, trustees will not want to be holding index-linked gilts at a time when markets are expecting a period of deflation and, if schemes are seeking to offload their unwanted linkers into a thin market with weak sentiment at around the same time, the hallmarks for systemic risk would seem to be present. Managing illiquid asset allocations is the second key challenge that our Vision 2030 paper identifies for DB schemes, particu- larly where their endgame is full buyout with an insurer. While schemes, insurers and their advisers are actively innovating to find solutions to the problems (for pre- mium payment) posed by outsized illiq- uid allocations, an inopportune illiquid allocation can, at best, complicate a trans- action and, at worst, hold a scheme back from achieving its objectives. No commentary on the years ahead for UK DB schemes could ignore the ineluc- table – and sharply accelerating – growth of the buyout market, so our paper con- siders the differences in regulation and


investment approach for insurance com- panies compared with DB pension scheme trustees when it comes to deci- sions around investing assets held to back liabilities and maintaining appropriate capital buffers against downside risk. But there are warning signals too, with Andrew Bailey, governor of the Bank of England, noting that the buyout boom could expose the insurance sector to “larg- er and more concentrated exposures to similar types of risks” which could poten- tially impact the capacity of surviving insurers to take on the back-book of a failed insurer. It is for a similar reason that Charlotte Gerken, the PRA’s director for insurance supervision, has called for “moderation” amongst bulk annuity in- surers, saying they should balance short- term incentives with the need for “long- term and enduring financial strength”. In that context, the paper considers the availability of the Financial Services Com- pensation Scheme (FSCS) and identifies its potential vulnerability to a change in the PRA rulebook and its status as an unfunded lifeboat with recourse only to levies on the insurance industry, both of which mean that, in a crisis scenario, the full availability of FSCS support could be dependent on political sentiment. Stepping back, Vision 2030 surveys a dif- ferent landscape than in 2012, with schemes generally in much stronger funding positions and running lower risk portfolios. This has brought the endgame within reach for many over the next dec- ade but, with that, comes a different set of challenges to manage and some impor- tant strategic questions to answer around the merits of buyout versus run-on.


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10 | portfolio institutional | October 2023 | Issue 127


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