Key findings of Hymans Robertson’s 2nd annual Trustee Barometer include:
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Only 5% recognise that being forced to sell growth assets at reduced prices to pay the pensions promised becomes a risk when a pension scheme enters material cashflow negativity
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Levels of awareness of this risk are almost 10 times as high amongst ‘professional’ independent trustees
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This risk materialises when the payments out of Defined Benefit (DB) schemes exceed the contributions in – increasingly the reality for the majority of UK DB schemes
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UK private sector defined benefit (DB) schemes are currently paying out around £20bn more per annum than they receive in contributions
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This is expected to worsen next year due to current ultra-low gilt yields and impending legislative change, rising to around £100bn in 15 years
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Despite this, only 4% of trustees are focusing on cashflow risk, and a mere 3% look at scheme income and outgoings as their starting point for managing the scheme
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Investing in assets that will deliver the income needed to pay today’s and tomorrow’s pensioners is the area of investment trustees spend least time focusing on
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Hymans Robertson has created a free mapping tool to help trustees understand how significant cashflow risk is for their scheme https://roadtoresilience.hymans.co.uk/
Hymans Robertson’s annual Trustee Barometer, an in-depth survey of 100 pension fund trustees of UK private sector DB schemes, has found that only 4% are focussing on the capital risks of paying out more in benefits than is received in contributions as they become increasingly mature, despite the majority of schemes either being or approaching cashflow negativity. Only 5% are aware of the real risk facing schemes when they enter this territory – the risk of having to sell assets at reduced prices to pay the pensions promised. Levels or awareness are almost 10 times as high amongst those at the vanguard of trusteeship - independent trustees, which indicates the need to raise awareness of this heightening risk more broadly.
Commenting on the lack of awareness of cashflow risk, Calum Cooper, Partner at Hymans Robertson, said:
"We asked trustees what they would change when they started receiving materially less in contributions than they were paying out in pensions - which is now or soon will be the reality for the majority of DB schemes due schemes maturing and a likely increase in scheme closures from April next year due to the end of contracting out, as well as an increase in transfers out to access DC flexibilities post freedom and choice. Worryingly over a fifth would do nothing. 39% would do more Liability Driven Investing (LDI), 27% would look to diversify their portfolio further and 6% would seek out lower volatility investments. Only 8% would put more focus on income generation.
“Most don’t recognise cashflow negativity as an issue, and certainly not one that requires a change in approach. Already £20bn more is going out of UK private sector schemes than is coming in. In light of this schemes should be structuring their portfolios to make sure they are not forced sellers of growth, or indeed illiquid, assets at a bad time.
“To meet pension payments both in the near term and into the future, trustees need to ensure their schemes have the assets in place to back cashflow requirements. Investments should be structured in a way that balances the need to generate required returns but avoiding exposure to capital losses or indeed frictional costs (a risk arising from being unable to hold income assets to redemption) through being a forced seller to pay promised pensions. On the liability side, to support the ongoing effective design of assets to back cashflows, the expected cashflows should be monitored and refreshed for ‘cashflow disruptions’ such as a pick-up in transfer activity or benefit changes.
“The risk of being a forced seller heightens the more cashflow negative a scheme becomes and the greater the proportion of assets the scheme holds that have significant capital volatility. DB schemes will be more risk resilient if they structure their portfolios in such as way so as to meet short, medium and long term cashflow requirements. This could be done by investing more in enhanced yield income generating assets alongside less and lower volatility growth assets. Examples include the fuller credit spectrum of bonds and loans, timberland, long dated secure property and other asset classes where the contractual cashflows make the scheme robust to any market setback.”
Discussing how trustees should approach risk management, he added:
“Schemes need to manage a wide array of risks on an ongoing basis – the likes of longevity risk, equity risk, credit risk, interest rate and inflation risk. Trustees have told us two years in a row that strategic risk management is a big challenge.
“For mature schemes investment strategy can make the biggest difference to de-risking. The biggest risk is what happens to the £1.2tn assets these schemes hold and whether it’s possible to out-run the cashflows. In that context, trustees should be considering their growth, income and protection needs when thinking about risk management. Where their relative focus should be depends on where they are on their risk journey, which is why we’ve developed an online tool to help trustees get a better sense of that:
“Flexing exposure to growth assets, income assets and protection assets makes a much bigger difference than any liability management initiative (like enhanced transfers, for example). In addition, seeking longer term cash commitments from sponsors can also enable significant investment strategy de-risking too – even if this means less cash for longer with less risk. Last year we showed if the FTSE350 adopted this approach it could increase benefit security by £25bn. Crucially, however, cashflow risk is becoming ever more significant and is clearly not on trustees radar. It needs to be a key component of all risk management strategies.”
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