Final Salary, Defined Benefit Pension Schemes Turn Negative
Cash flow negative schemes lack sufficient income from investments and contributions to pay member pensions, so typically need to sell assets to meet their liabilities. Consequently, they are more vulnerable to market corrections since they may be forced to disinvest during a period of market stress.
Mercer’s report also noted that, in parallel, pension schemes are investing in alternative assets that offer some additional return in exchange for reduced liquidity and greater complexity as well as providing a regular income stream. The average allocation to alternatives increased in 2017 to 22% compared to 21% in 2016 (up from 4% in 2008).
Mercer’s Global Director of Strategic Research said, “While many private markets have seen significant inflows in recent years, opportunities remain for high quality managers to extract returns in less liquid and more complex markets. This is especially true in areas where the supply of capital remains constrained – most notably private debt finance for smaller companies who have limited access to the capital markets. Such income generative assets can help investors meet their cashflow needs whilst also reducing their exposure to equity risk.
He continued, “Being cashflow negative is a natural life stage of a mature DB pension scheme, of course, but recent stock market performance may have lulled some into a false sense of security. Our report highlights that less than 40% of schemes have a formal de-risking journey mapped out. This leaves a large body of schemes with no clear plan in place.”
Trustees of cashflow negative schemes need to be sure that, in the event of a large market correction, liquid assets are available to meet cashflow and collateral needs, without requiring the scheme to crystallise losses. We would encourage all schemes – large and small – to use scenario planning and stress-test analysis to understand how a market correction might impact their financial health.”
This is the 15th edition of Mercer’s annual European Asset Allocation Report. The 2017 report survey gathered information from 1,241 institutional investors across 13 countries, reflecting total assets of around €1.1 trillion. This release deals only with UK scheme information.
The report highlights that de-risking continues to be a dominant trend in the UK pensions industry with 47% of respondents stating that their long-term funding objective was self-sufficiency, 36% focused on their technical provisions liabilities and 17% targeting buy-out.
In terms of asset allocation (See Chart 1) since 2008, UK plan equity allocations have halved from 58% to 29%. Report participants see this continuing, expressing their intention to further cut equity allocations in the years ahead. Indeed, in 2016, equity allocations fell as some schemes took opportunities to de-risk in the latter part of the year as equity markets and bond yields rose. Equity allocations averaged 29% in 2017 - compared to 31% in 2016 - while allocation to bonds rose from 48% to 49%.
Mercer’s report showed an increase in exposure to hedge funds (from 33% to 37% of investors covered by the survey) as investors respond to the challenging environment for traditional market exposures (such as equities and bonds).
If you have a Final Salary or Defined Benefit pension scheme and you are unsure what to do, simply complete the contact form on our main page www.qropspensionservice.com and a UK based and UK regulated pension advisor will contact you to discuss your options.