Key points:
• A third of CFOs** recognise their Defined Benefit (DB) schemes are now paying out more in pension payments than received in contributions
• Research* shows 50% of FTSE350 DB schemes are now in this situation
• Awareness of the risks this poses is higher among CFOs than trustees – 1 in 5 CFOs recognise that a forced sale of assets to meet pension payments is the biggest risk to their DB scheme compared to only 4% of trustees
• In 2015 £20bn more was paid out in pensions than received in contributions across UK DB schemes
• This will increase to £100bn by 2030
Earlier this month the Pension Regulator (tPR) underlined the importance of DB schemes understanding and managing cashflow risk for the first time.
Commenting, Jon Hatchett, Partner and Head of Corporate Consulting at Hymans Robertson, said: “According to our analysis, 50% of FTSE350 schemes are already, or soon will be, in a situation where pension payments exceed the contributions coming into the scheme – in other words ‘cashflow negative’. The problem is only going to get worse as schemes become increasingly mature.
“Being cashflow negative heightens the risk of being forced to sell assets at a time when you either hadn’t planned to or don’t want to, perhaps due to a dip in markets. Being a forced seller of an asset with a volatile price should be avoided at all costs, as during a market slump a greater proportion of the asset base needs to be sold to meet benefits. The remaining funds then have less potential to bounce back in a market recovery. It’s reassuring to see that CFOs are aware of this risk.
“The past 16 years have been tough going for sponsors of DB schemes. Companies have spent £500bn on pensions since 2000, yet the combined deficit across UK DB schemes stands at £800bn. Forced asset sales destroy value and will only exacerbate the situation unless there’s a change in approach.
“We were delighted to see the Pensions Regulator bring the issue to the fore earlier this month. The risk of being a forced seller of assets is largely a new one for DB schemes, but will continue to grow in scale. It’s essential to look at the cashflows generated by scheme assets and the extent to which they could meet liabilities. It’s an approach we have advocated for some time and it’s reassuring that it is beginning to gain traction in the wider market. The issue will be better managed as a consequence.”
Discussing recent high profile pension schemes being assessed for entry into the pensions lifeboat, the PPF, he added: “The potential plight of BHS and other workers has brought the relationship between company sponsors and their DB schemes into the spotlight. It’s easy to jump to the assumption that if a company can pay more to shore up their DB schemes, they should do so.
This 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.”
Providing a steer on what schemes should do to become more resilient to risk, he said:
“Our clients have weathered the financial storms of the last few years well. They’ve become more resilient to risk by doing three things. First, having a clear purpose – setting measurable objectives to drive their strategy. Second, proceeding at a controlled pace, recognising there’s no need to be fully funded as schemes will be paying pensions for many decades to come. Making a conscious decision not to get to try and get to the end point as quickly as possible is one of the simplest ways to reduce risks and survive the bad times intact.
“Finally, having more accurate and precise information upon which to base decisions. For too long schemes have been relying on member data that is up to three years out of date. This is a crazy state of affairs in the 21st Century, especially with the flux caused by the pension freedoms. Schemes can get valuations that are bang up to date at no extra cost. When they do it’s possible to make better decisions and take advantage of opportunities to de-risk.”
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