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CASH IS KING FOR DB PENSIONS Norbert Fullerton
Head of institutional client strategy, EMEA Janus Henderson Investors
Strategies focused on generating income need to be a key feature for DB pension funds in 2020 and beyond.
The changing landscape
In 1998, one of my first tasks when I entered the actuarial profes- sion was to work out the level of defined benefit (DB) pension fund surplus that could be refunded to the sponsoring employer or shared with members via uplifts to their pensions. Those were the good old days when most pension funds were open to new members. Today, the DB pensions landscape has changed dramatically. Most DB pension funds are closed, have increased in maturity, have huge deficits and are focused on managing various risks associated with their sponsor, assets and liabilities. Funding levels have also improved since the nadir of the global financial crisis, thanks to the last decade of deficit payments from sponsoring employers and a bull run in equity markets. Trustees and sponsors have, therefore, shifted their focus towards conservative endgame strategies.
Whether the endgame strategy is to achieve self-sufficiency (i.e. there is low dependency on the sponsor) or to transfer liabilities to a commercial DB consolidator, or buyout with an annuity provider, the challenges are the same. While funding levels have improved, the vast majority of DB pension funds still need to become fully funded on a conservative measure, so that they can pay all mem- bers’ benefits when they fall due.
Why CDI? Shockingly, within 10 to 15 years, almost all DB pension funds will be cash-flow negative, meaning that they do not have enough income to pay their outflows, such as members’ benefits. To manage the cash-flow negative problem, most DB pension funds are disinvesting assets to pay pensions. That is not a sus- tainable solution. If they sell their assets at the wrong time, espe- cially when market values are depressed, and their pension fund is in deficit, they could run out of money fairly quickly or need extra sponsor support.
Other pension funds have opted for their investment mandates to distribute income where possible. However, this is just a ‘stopgap’ because many of those mandates do not usually produce a suffi- ciently high level of income.
The answer lies with a more optimal approach: it is imperative that trustees and sponsors refine their portfolios and adopt cash-flow
20 March 2020 portfolio institutional roundtable: Fixed income
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