News & analysis
Trustees sell assets to pay pensions as cash-flow negativity in UK impacts 73% of DB schemes
The number of cash-flow negative defined benefit (DB) pension schemes in the UK is rising, Mercer claims. For almost three-quarters (73%) of such schemes the amount of benefits paid out annually is higher than the new contributions they receive. This is an increase of 7% since the start of the year.
The rise is mainly a result of more and more final salary plans maturing, with many now closed to new members and new accrual of benefits. Selling assets is the most common way that cash-strapped schemes are raising the capital needed to pay their pensioners in full, with 91% of respondents fol- lowing this route. There has, however, been a rise in alternative ways of funding a shortfall.
Leveraging invest-
ment managers to distribute income from the assets in their portfolios has been used by 48% so far this year, up from 43% in 2018. Cash-flow matching strategies have also been on the rise, almost doubling to 9% of
respondents from 5% last year. This is where schemes buy assets that distrib- ute cash at periods that match required outflows from a portfolio. This is a strategy that is favoured by Mercer investment consultant Matt Scott. “Investors should consider developing a strategy to meet cash-flows, to avoid relying solely on disinvestment which can be complex and expensive,” he said. “We believe that cash-flow matching techniques, where portfolios are specifi- cally designed to align income and principal receipts, will be more widely adopted in the coming years, as DB plans continue to mature.” Having a clear strategy is important as 27% of UK DB plans (24% in 2018) have transferring pension assets and obligations to an insurer as their long- term target.
Rise in asset prices sends FTSE 350 DB scheme deficits lower in June
The aggregate deficit of defined benefit (DB) pension schemes for the UK’s 350 largest listed companies fell during June, according to a report published by Mercer. The combined shortfall of final salary schemes spon- sored by the companies trading on the London Stock Exchange’s main market stood at £48bn at the start of July. At the end of May the figure was £57bn. The largest driver here was an improvement in asset val- ues, which stood at £812bn at the end of June, a £13bn rise since the start of the month.
This offset a £4bn increase in liability values to £860bn due to a slight decline in corporate bond yields, but was mitigated by a 0.05% fall in market-implied inflation. Yet Mercer actuary Charles Cowling warned that trus- tees should not be complacent. He said that despite the welcome decline in the deficit, significant macro-eco- nomic and political headwinds remain. “The UK awaits a new prime minister following Theresa May’s resignation last month and Britain’s negotiating position on Brexit is far from clear, a combination of global trade tensions and an increased perceived likeli- hood of a no-deal Brexit means we expect market volatil- ity to be a consistent feature of the months ahead. Lower energy prices and weakening UK growth are reflected in CPI inflation falling back recently. “However, a Brexit sterling crisis and resulting inflation shock is still a real possibility. In this uncertain environ- ment trustees should continue to prioritise risk manage- ment and actively seek to take advantage of market opportunities to de-risk.”
The deficits were calculated by Mercer using the approach companies use for their corporate accounts.
PIC’s record breaking H1 for new business and longevity reinsurance
Pension Insurance Corporation (PIC), a defined benefit (DB) pension fund insurer, completed £5.8bn worth of de-risking deals in the first half of 2019.
It has also reinsured £7bn of longevity risk, which includes almost £1.5bn of deferred savers. This is the first time such a signifi- cant amount of deferred lives has been reinsured in any one period and signals increased capacity for this type of risk within the reinsurance market. So far this year, PIC has de-risked pension
schemes sponsored by retail giant Marks & Spencer, consumer specialist the Co-opera- tive Group and investment bank Dresdner. It has also completed £3.3bn worth of new business with un-named pension schemes. PIC has now reinsured more than 70% of its longevity exposure, signing treaties with 11 reinsurance counterparties. Longevity reinsurance is part of PIC’s business model. It wrote its first longevity reinsur- ance contract in 2008 and completed £5.6bn of deals in this area 10 years later.
8 | portfolio institutional | June–July 2019 | issue 85
PIC’s chief original officer, Jay Shah, said it has been a record-breaking first half for the firm in terms of the amount of new busi- ness transacted and longevity risk re-insured. “We are especially pleased to have insured such a large amount of deferred lives,” he added.
“This is a significant development for the reinsurance market, where we are now starting to see the standardisation of these types of deals, which we have had for several years for pensioner deals.”
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