In a survey of pension schemes representing over £120bn worth of assets, PwC and Redington found a consensus amongst schemes that interest rate and inflation risk were now the two biggest issues impacting their de-risking journeys, with equity and market risk relegated to third place. However, further analysis carried out by the two firms found a clear divergence in how schemes are practically managing these risks, with reported interest rate and inflation protection ranging from 20 per cent to 100 per cent.
Commenting on the findings, Paul Kitson, partner and head of risk transaction at PwC, said: “Our data suggests that schemes have split into two camps – those that have low levels of interest rate protection and are still at an early place in their risk management journey, and those that have bitten the bullet in recent years and have been quietly increasing their hedging of interest rate and inflation risk to 70 per cent plus.
“It appears that many schemes have overcome the ‘regret risk’ of hedging interest rates and inflation in what some may argue could be the bottom of the market. These schemes are now increasingly shielded from further changes in interest rates and inflation expectations, be it positive or negative. However, many UK pension schemes still remain significantly exposed to interest rate and inflation changes, which means for these schemes there is the potential for deficits to reduce if interest rates rise faster than expected, but also the potential for deficits to increase still further if interest rates fall, or increase slower than expected.”
The survey also assessed attitudes towards risk transactions, finding that more than three-quarters of schemes planning a buy-in or buy-out transaction are considering medical underwriting – an assessment of member health - as part of the process.
However, less than 5 per cent of schemes are what could be described as “trade ready”, which PwC argues could lead to unexpected delays and costs when schemes are ready to transact.
Paul Kitson said: “Despite some form of transaction being on the cards sooner or later for most schemes, it is surprising how few are actually “trade ready”. For many, the decision to proceed with a transaction will be based on pricing and we encourage schemes to pre-empt activity by ensuring the data and in particular documentation are in place.”
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