Travel towards endgame has accelerated
The buoyant mood surrounding the pension scheme derisking market has received further evidence that confidence is based on fundamentals, not sentiment.
Barnett Waddingham’s monthly defined benefit End Gauge index (see graphic) shows that over the past 12 months, the average time for pension schemes to reach a sufficient level of funding to buy out their liabilities with an insurance company has almost halved to around 5.5 years from almost 10.5 years.
Changes in the index over time illustrate the positive and negative impacts of various factors on pension scheme journeys. This reinforces the need for the scheme’s strategy to incorporate monitoring and trigger points for actions to ensure they remain on course for their endgame.
A more manageable problem
The index increased slightly in January 2023 to 5.44 years from December’s 5.4 years as a fall in bond yields caused liability values to rise. That impact was in part offset by a slight drop in long-term inflation expectations, and strong asset performance exceeded the increase in liability values.
As of February 21, the index had dipped to 5.26 years – a slight decrease over the past two months as a result of a drop in assets and liabilities, with liabilities reducing more.
There is an assumption that assets have declined across the board. Fixed income, in general, and index-linked gilts performed poorly and the unhedged FTSE All World TRI returned minus 1 per cent over the period since January 31, though other FTSE indices not employed by the End Gauge calculation have shown positive returns.
Liabilities were also reduced by an increase in gilt and swap yields over the period – for instance 18-year gilts increased by around 0.3 per cent – with inflation remaining broadly stable.
Grasping the nettle
Barnett Waddingham partner Simon Taylor said: “Since its inception at the end of 2020, our End Gauge measure has reflected a stable period for interest rates and inflation, and the deficit contributions being paid by scheme sponsors.
“It started to fall more rapidly in 2022 as interest rates started to rise, and ended 2022 with time to buyout at half the level of the start of the year.”
He said this is borne out by anecdotal evidence from clients and other schemes and, with a few exceptions, schemes have seen a significant increase in their funding levels over 2022, despite the turbulence caused by the liability-driven investment collateral call issues.
This can only be good news for scheme sponsors facing an uncertain economic outlook with supply chain issues, rising prices of raw materials, and a potential recession on the horizon.
“Sponsors now have a chance to rethink their pension strategies and contribution levels,” Taylor said.
“Some may want to reduce contributions so they can deal with wider business pressures, others may wish to get their schemes funded to buyout levels so they can transact with an insurer and remove all pension risk from their balance sheets and [profit and Loss accounts], allowing them to focus on the day job in difficult times.
“Some sponsors will face refinancing, restructuring or corporate transaction activity over the next few years and the impact of these on the pension scheme will be a key part of the considerations. These sponsors should also be thinking about a shorter-term strategy for their pension schemes so that they do not adversely impact on these activities.”
Don’t leave it too late
The End Gauge’s underlying data indicates that the very largest schemes, with assets in excess of £5bn, appear to be significantly better funded than smaller schemes with assets of less than £1bn.
Taylor said this is good news for insurers looking to write large bulk annuity transactions, but it means there is likely to be many smaller schemes coming to market in six or seven years and it will be crucial that they have got themselves transaction-ready before then.
Short-term and long-term strategies should be flexible enough to navigate through these headwinds
As ever, benefit audits and data cleansing are essential tasks and best done sooner rather than later. There is no reason why schemes cannot be getting on with these activities now, even if they are a few years away from a transaction.
Taylor addd: “In general, UK schemes are in the healthiest position they have been in for years, but sponsors and trustees should not be complacent given the expected challenges over the next few years.
“Short-term and long-term strategies should be flexible enough to navigate through these headwinds.”
Know your place and get your timing right
Some believe there is an increasing need for the bulk purchase annuity market to be seen as a far more mixed market than it has been to date.
Different schemes from different sectors and differing qualities are at different stages of their life cycle.
Last year’s liquidity crisis did nothing to change the direction of travel, if anything it accelerated the move to endgame. But it may result in a starker differentiation between liquid and illiquid assets.
Schemes should be aware of their likely place in the endgame to ensure they are not forced to make rapid changes in strategy to avoid – or endure – a lack of capacity in this very busy market.