Experts eye hedging and CPI as UK DB deficit up £170bn in weeks

Experts urged schemes not to waver from their long-term strategies, but stressed the importance of hedging against interest rates despite the apparent costs.

There were also calls for the Work and Pensions Committee to lessen the strain on the industry by making nationwide changes following its British Steel consultation, rather than making special provisions for the fund.

We don’t want the good guys – who are the guys who have provided their employees with defined benefit pensions – to suddenly be the commercial pariahs of society

Rosalind Connor, Arc Pensions Law

Research conducted by consultancy Hymans Robertson revealed that as of June 16 pension deficits had grown by five per cent of GDP in just six weeks, reaching £850bn.

With the announcement of the referendum result the next week, deficits jumped a further £50bn to reach £900bn.

In early June it emerged pension liabilities now stand at more than £2tn, with one in seven finance directors surveyed saying their DB scheme is a major risk to their business.

Hedging a must to prevent further deficit growth

Andy Green, chief investment officer at consultancy Hymans Robertson, said that while Brexit and its impact on gilt yields had not helped schemes, “the nature of the risk that they take to try and generate more returns” poses a far greater threat.

He also said deficits had suffered from sustained exposure to equities and falling interest rates.

“There are plenty of assets around that give you a decent and more predictable return through yield and through income sources, which would provide a less volatile path,” he said.

He added to calls for schemes to hedge against interest rate fluctuations, despite the perceived high cost of liability-driven investments in a low-yield environment.

A renegotiation of contributions?

Rapidly growing liabilities and stable, but not strong, investment returns might lead some trustees to re-examine their sponsoring employers’ contributions.

A study by investment platform AJ Bell earlier this month found that eight of the 20 companies with the largest pension deficits paid out more in dividends than the size of the deficit.

Rosalind Connor, partner at Arc Pensions Law, said the current moral hazard powers wielded by the Pensions Regulator were sufficient protection against excessive dividends being paid by companies with large deficits.

She added that schemes run by FTSE 100 companies are unlikely to qualify as pension funds with no realistic chance of meeting their liabilities.

Prioritising pension funds over shareholder dividends – the measure by which many companies judge sustainable growth – could have an adverse effect on the industry, she said.

“We don’t want the good guys – who are the guys who have provided their employees with defined benefit pensions – to suddenly be the commercial pariahs of society,” said Connor.

CPI offers potential lifeline

It has been suggested that switching all pension benefit increases from the retail price index of inflation to the consumer price index, in the wake of the DWP’s consultation on British Steel, could ease the strain on the sector’s largest deficits.

"You haven't got to do a lot to future pension increases to make a big difference to the solvency of schemes," said Kevin Wesbroom, principal consultant at Aon Hewitt.

Statutory pension increases for future accrual were changed to CPI in 2011, but Connor explained that some schemes have been prevented from making this switch by their own rules.

This would occur where their compliance with the old legislation made explicit reference to RPI in scheme documents. “It seems terribly unfair from that point of view,” she said.

The number of UK schemes at risk of falling into the Pension Protection Fund was estimated last month by the Pensions Institute’s director David Blake at “up to 1,000”.

“There would be plenty of ways to address the question, but let’s not have a knee-jerk reaction,” said Wesbroom. “The one thing we’ve learnt is that knee-jerk pensions legislation is really bad.”