With many schemes now well-funded; some trustees and sponsors may be faced with a buy-out dilemma, and need to weigh up the opportunity cost of an insurance transaction versus the alternatives.
Looking at approaches taken in other countries may help with solutions for that dilemma.
Bond yields and future market expectations of inflation increased over August while equities deteriorated slightly. The funding position of the FTSE 350 pension funds on an accounting basis shows a slightly smaller surplus than at the end of July according to Mercer’s Pensions Risk Survey data analysis for August 2023.
Mercer’s Pensions Risk Survey data analysis for August 2023 shows that the accounting surplus of defined benefit (DB) pension schemes for the UK’s 350 largest listed companies decreased to £52bn at the end of August 2023. The present value of liabilities decreased from £583bn at 31 July 2023 to £576bn at the end of August 2023 driven by a rise in corporate bond yields, offset by a rise in market-implied inflation. Asset values decreased from £637bn to £628bn at the end of August 2023.
Graham Pearce, Mercer’s Global Defined Benefit Segment Leader, said “The UK DB pensions market finds itself at a crossroads, as many schemes are nearing the funding level needed to secure benefits with an insurer.”
“As more DB liabilities move to the balance sheets of a smaller group of insurers, it is important to think through the implications of this change in how the UK delivers DB pensions. In other parts of Europe, consolidation into large, robust and well-governed vehicles has generally been preferred to the buy-out route. Many of those are operating like insurance companies, making appointments to bring their standards of governance in line with insurers. Under a consolidation approach, pensions can potentially be financed with a healthier risk appetite than can be tolerated by an insurer, which can lower the cost of pension provision.”
The UK Government, has suggested there is potential for “DB schemes to work harder for members, employers and the economy” and is currently gathering evidence on options for DB pension schemes, including on the role of consolidation.
John O’Brien, Strategic Risk Management Leader for Europe, added “The cultural and legal backdrop for pensions can vary hugely. While comparison of risk transfer patterns with the UK is informative, it does not always tell the entire story. In many countries, there is simply no active risk transfer market. Pension plans have little option but to soldier on. Where risk transfer markets do exist, developed countries tend to have confidence in the insurance regime. But the reality is nobody knows where politics could take that regulation over time. As history has shown, there can be political gain in relaxing regulation when memories of past financial crises fade.”
“The UK is fortunate to have markets for risk transfer and alternatives which coexist, challenging one another. Risk transfer to insurance companies will be the decision made for many schemes but, for the sake of financial stability and member outcomes, it’s a decision which shouldn’t be reached without that challenge.”
Mr Pearce and Mr O’Brien’s The pension buy-out dilemma: In defence of long-term investing takes a deeper dive into the international pros and cons of risk transfer, discussing the acceleration of pension buy-out, the opportunity cost of insuring benefits, and the alternatives on offer.
Mercer’s Pensions Risk Survey data relates to about 50% of all UK pension scheme liabilities, with analysis focused on pension deficits calculated using the approach companies have to adopt for their corporate accounts. The data underlying the survey is refreshed as companies report their year-end accounts. Other measures are also relevant for trustees and employers considering their risk exposure. Data published by the Pensions Regulator and elsewhere tells a similar story.
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