UK pension scheme funding levels fell over July as liabilities increased sharply due to tumbling gilt yields. Ongoing uncertainty around Brexit, particularly following the change of Prime Minister, meant the pound fell and further weakened many UK schemes’ sponsor covenants. With geopolitics also continuing to drive markets we saw a largely “risk off” environment. The much-anticipated US rate cut happened at the end of the month, and many expect other central banks such as the ECB to follow suit. In the UK, the 10 year yield fell 21 basis points to finish the month at 0.7%, while longer dated yields also fell around 17 basis points.
This, in combination with rising inflation expectations, meant UK liabilities finished the month nearly 5% higher than at the end of June.
While equities crept 1-2% higher and hedging strategies will have helped many schemes, the PPF 7800 Index still fell 2% over the month to finish July at 95.0%. At the risk of sounding like a broken record, those schemes with LDI strategies in place will have been cushioned from the impact of falling yields and rising inflation.
These typically better funded schemes in particular are increasingly focussing on the “endgame”, be that insurance solutions, consolidation or self-sufficiency strategies. On the latter, we continue to see interest from reasonably well funded schemes to implement bespoke cashflow matching and liability hedging portfolios. We advocate a fully integrated strategy which considers three key factors in combination: return, risk and cashflow. Such a strategy, including credit, LDI and private markets assets can generate up to 1.5% p.a. above liabilities, with a healthy income stream. This can help to close any funding gap versus a self-sufficiency target over the medium term, while also generating cashflow for pension payments. For those schemes and sponsors with long term horizons, who don’t want to pay substantial insurance premiums for removing longevity risk, this may be a suitable endgame target.
On the other hand, the full risk transfer option of a buyout remains the ultimate goal for most schemes, but it’s still some way off for most. Many consider transacting buy-ins along the journey, and these approaches continue to grow in popularity. According to LCP, a record £34bn of buy-in, buy-out and longevity hedging deals were completed over the 12 months to the end of June. With nearly £20bn in the pipeline for the remainder of the year, some have voiced concerns around capacity: will this impact pricing or the ability for smaller schemes to buyout?
However despite this increasing demand (and noise), the majority of schemes, representing over £1 trillion of assets, are not yet in a position to transfer assets to an insurance company. Some of their sponsors will also have little appetite or even ability to continue to fund the pension deficit. For these, pensions consolidators offer an alternative approach, and there has been lots of talk in the pensions press around this. As this market becomes more established, many trustees and sponsors will consider this type of uninsured risk transfer. While we see clear merits in these solutions for many schemes, it’s early days and they are still relatively costly versus targeting a longer term self-sufficiency strategy.
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