UK defined benefit (DB) pensions shortfall driven by record lows in gilt yields
UK pension deficit hits record level of £935bn on Monday
01 Jul 2016 - Estimated reading time: 2 minutes
- Record lows in gilt yields pushed the liabilities of UK pension schemes up to an all-time high £2.3 trillion on Monday;
- The UK aggregate deficit is now the worst it has ever been by around £25 billion;
- Trustees should take a closer look at the strength of their company sponsor post-Brexit to ensure risks are managed as well as possible to protect members’ benefits;
- Trustees of schemes in the airlines, housing and financials sector should sharpen their focus on covenant in particular.
Hymans Robertson, the leading pensions, benefits and risk consultancy, has shown that the combined funding position of UK Defined Benefit (DB) pension schemes hit a record low this week due to falling yields as a result of the ‘flight to safety’ post the Brexit vote. This comes off the back of weeks of plummeting deficits and a sustained period of volatility for pensions.
Commenting on what’s happening to yields and the impact on liabilities, Patrick Bloomfield, Partner at Hymans Robertson, said:
“Although rating agencies may have downgraded their view of gilts (British government debt), they are more expensive than ever to buy. Regardless of what rating agencies have to say, many investors are willing to pay sky high prices for gilts for the security offered by the British government, even if this is now outside the EU. Some investors are effectively forced into buying gilts because of the way financial regulations work. Perversely, higher gilt prices could increase demand for then, pushing gilt prices higher still and potentially sending pension liabilities further north.”
Discussing the need for trustees to understand how Brexit has impacted the health of their sponsoring companies, he said:
“Those running DB schemes need to remember that pensions are long-term and should avoid knee jerk reactions to short term market volatility. The gyrations in UK pension deficits are eye-watering. But one of the biggest factors that will determine whether or not pensions are paid to scheme members in full will be the health of the sponsoring company post Brexit. This should be a primary consideration when making funding decisions for DB schemes.
“The consensus view is that the short-term economic effects of Thursday’s vote will be predominantly negative. But aggregate figures mask a varied picture. This week companies will be looking at contingency plans and trying to get a handle on what the impact on their business will be, both now and in the long-term. Trustees will rightly want to understand what these plans look like and reassess their scheme funding strategies accordingly.
Discussing the sectors that have been hit hardest, Bloomfield added:
“The best way to support the pension promise is to have a healthy business sponsoring the scheme. Post Brexit, some parts of the economy will look healthier than others. Some sectors have taken a battering in stock markets, including financials, housebuilders and airlines. The outlook for companies with a UK market focus – in other words, those that won’t benefit from sterling weakness, and those that are reliant on importing raw materials, will have changed.
“Trustees of schemes in these areas need to reassess the financial ability of their sponsoring company to support their scheme now and in the future. This ability, also known as ‘employer covenant’, should always be a key factor when assessing the likelihood of individual’s pensions being paid in full. But it isn’t always assessed appropriately. The importance of understanding covenant risk has been underlined by several high profile schemes recently being assessed for entry into the pensions lifeboat, the Pension Protection Fund (PPF), such as Tata Steel and BHS.
Discussing what trustees should do in the event of weaker covenant, he added:
“Should covenant be weaker, trustees need to strike a healthy balance. The business needs to be viable on an ongoing basis so trustees need to avoid demanding so much it pushes the sponsor out of business.
“Trustees need to remember that if the pension becomes too big a burden for the company and it fails, pensioners will lose out to the tune of £45,000 on average if they have to be caught by the the PPF. And there are fears about how many schemes the PPF can absorb without significant drops in the levels of protection it can give pensioners.
“The Pensions Regulator has effectively said that where sponsors can pay more, they should do so. Whilst this may sway popular opinion in light of the events at BHS, it won’t be right for everyone. The focus on cash contributions has distracted too many from the greater challenge of managing the risks in pension scheme funding.
“Even if cash contributions were to magically double, they would still be dwarfed by the volatility of UK plc’s pension balance sheet. What we should be focussing on is ensuring contributions that are adequate in the circumstances and stable for the employer. This stability will provide management time and space for the challenging job of managing the risks in DB funding as well as the challenges of adjusting to a post-Brexit world.”