Don’t panic over 2020 valuations

Even before Covid-19 we were already seeing historically low gilt yields. With the majority of schemes also maturing quickly, particularly after transfer activity on the back of the 2015 pension freedoms and the market shocks we have now witnessed, the horizon might look to be darkening for schemes approaching a valuation.

The key question, then, is how should these events affect long-term strategy in light of all of the above?

My mind immediately turns to the Hitchhiker’s Guide to the Galaxy – “don’t panic”, particularly if you have a valuation coming up in March/April.

Pension schemes are still long-term arrangements and, subject to care being taken over the day-to-day functioning of the fund, there is time to consider and plan the next steps.

Rushing into any changes now would be a mistake – market volatility means that asset transactions are risky and have the potential to go wrong.

Inadvertently selling out at depressed asset prices could have a significant impact on the long-term plan and, as a result of an increased deficit, lead to more strain on the sponsor. 

Knowledge is key

Instead, trustees should work from a position of knowledge. They should look carefully at their funding position, relative to long-term objectives, and understand which of the factors above has had an impact.

Most advisers now provide the tools necessary to do this, even if the trustees do not always have direct access.

Schemes are likely to fall into two camps – those that have hedged interest rates and those that have not. 

Where hedging is in place, the scheme will have been largely protected against the fall in long-term yields and, as a result of improvements in bulk annuity pricing (which is partly based on credit spreads), may now be closer to buyout than they previously were.

This could prompt a conversation with insurers about how best to capture this upside. 

It is also likely that longevity risk is a relatively major issue for these schemes and so it would be wise to review their derisking options, from longevity swaps for larger schemes through to “top-slicing” larger liabilities for smaller schemes.

Don’t bury your head in the sand

For less well funded schemes with hedging in place, and subject to the employer covenant, the fall in return-seeking asset values could present an opportunity to re-risk, in order to capture any potential rebound in either traditional or alternative assets.

However, careful thought is needed about the way in which these opportunities are taken, given the volatility of markets.

Such a strategy will require a stronger employer covenant, and trustees should be mindful that the strength of the covenant pre-crisis may not necessarily endure as we emerge from it. 

Schemes without hedging in place are likely to have seen a significant increase in their deficits, albeit offset by the significant fall in long-term inflation expectations. They are the least likely to find any easy answers at this stage. 

However, they should also consider the impact on long-term strategy, and work collaboratively with the employer to understand where they stand and the actions that they might be able to take.

Measured response

For trustees facing the prospect of sponsor distress, including the potential of insolvency, contingency planning is essential.

Dealing with the basics, such as control over scheme bank accounts and avoiding reliance on the employer payroll for pensioner payments where possible, would be a sensible first step.

Recent events are not necessarily bad news for all pension schemes. The impact will vary considerably by scheme, but it is more important than ever for trustees to fully understand their circumstances.

They can then take measured decisions in the context of their long-term strategy, and work closely with their advisers to carefully implement any changes they think are needed.

Charles Ward is a professional trustee at Dalriada Trustees