Key findings include
- FTSE350 defined benefit (DB) schemes are currently paying out £13bn a year more than they receive in contributions, with this figure set to rise to £50bn by 2030
- Being ‘cashflow negative’ is an issue that half of FTSE350 DB schemes now need to contend with
- And the situation is set to worsen with a likely increase in scheme closures due to legislative change reducing the amount of money being paid in
- Corporate treasurers wouldn’t tolerate cashflow risk in the business; they should apply the same principles to managing cashflow risk in their DB pension scheme
- Ensuring scheme assets can back the payments due to pensioners should be the number one priority for those who are or soon will be cashflow negative
- Yet only 4% of schemes are prioritising investing in the assets that will deliver the income needed to pay pensions*
- This opens schemes up to the risk of being a forced seller of assets to pay the pensions promised
Commenting Jon Hatchett, Partner at Hymans Robertson, said:
“This is against a backdrop of the FTSE350 aggregate deficits remaining persistently stubborn, despite companies paying in £250bn since the start of the millennium. The three big positions taken by most schemes have backfired: equities are at half the level expected in 2000, interest rates have increased liabilities by over 50% and continued rises in longevity have added a further 10-15%.
“Companies need to learn from the experience of the last 15 years and look for opportunities to make their schemes more resilient to risk, thereby reducing the chance of having to pay in more cash in the future or of being forced sellers of growth assets at depressed prices.”
Discussing the cashflow issue facing half the FTSE350, he said:
“Given half of FTSE 350 schemes are, or are approaching, being cashflow negative, investing in assets that will deliver the income needed to pay today’s and tomorrow’s pensioners is key. Yet only 4% of schemes see this as a priority.
“Companies have to take action to ensure their scheme can generate the required income from scheme assets without being a forced seller at reduced prices – otherwise they will return to their sponsor for more cash. Firstly they should review whether they have income generating assets in place to meet shorter term income requirements. Growth or illiquid assets can then be used to back longer dated cashflows where there is no immediate need to realise capital.
“Switching to an approach of having the assets to back the benefit payments – i.e. focusing on the extent and timing of a scheme’s cash needs as well as the overall return required – will make schemes far more resilient to risk. Unfortunately market volatility is the norm rather than the exception, and this approach would result in more resilient portfolios, particularly during market downturns.
“Corporate treasurers are well placed to managing cashflow risk. It’s a risk they wouldn’t be prepared to tolerate in the business, so why do it in the pension scheme?”
Commenting on the impact of legislative change on scheme running costs, he said:
“It’s highly likely we’ll see more closures among the two thirds of FTSE350 schemes that remain open to accrual due to legislative change increasing DB costs. Next year is a big one for DB schemes. April 2016 sees both the introduction of further pensions tax changes and the end of contracting out. Both of these are likely to prompt companies to review the future cost of DB benefits.
“Meanwhile, the April 2015 pension freedoms have started to bed down. While many companies have adopted a ‘wait-and-see’ approach, scheme experience and market solutions are now developing, meaning sponsoring companies should revisit how to help former employees make better informed retirement choices.
Discussing how companies should approach risk management more generally, he said:
“Companies need to understand where their scheme is on the road to reaching maturity. This will help them to prioritise and manage their key pension risks, ultimately delivering more certain outcomes. It also helps companies schedule a body of work to get to their desired destination: being in position where they don’t cause any financial strain on their sponsors.”
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