Schemes urged to revisit risk as deficits soar

Research conducted by PwC’s Skyval Index reveals that the deficit of the UK’s circa 6,000 pension funds grew by £100bn in the last month on a funding basis, bringing the total deficit to £710bn.

Any beliefs they had, any principles they had adopted previously around the way they derived the strategy for their pension scheme are probably now outdated

Raj Mody, PwC

Skyval, a pensions platform, uses accounting, funding and buyout measures to provide a regular health check on the UK's DB pension schemes.

Raj Mody, partner and global head of pensions at PwC, said that schemes and companies should be revisiting their approach to risk given the current low-yield environment.

“We are clearly in a world now of an expectation of a different kind of yield environment [and] a different kind of economic environment,” he said.

Long-term yields have continued to drop and pension schemes now "probably need to review their strategy”, said Mody.

“Any beliefs they had, any principles they had adopted previously around the way they derived the strategy for their pension scheme are probably now outdated, because I don’t think many commentators envisaged these kinds of market conditions,” he added.

Mody said that this does not necessarily mean that all current strategies are incorrect, “but you do need to re-verify whether your strategy still works for current conditions… and I wouldn’t be surprised if most pension schemes… find they need to make changes”.

He said: “Now those changes might be very benign and proactive,” such as member option exercises.

Mody also said that pension funds should ask themselves whether gilt yield measurements are still relevant to them when measuring and financing the deficit, because there may be more appropriate measures that are better suited to a fund’s strategy.

Gilt yields have “ended up being a convenient objective measure, but that doesn’t mean that they’re right,” he said.

But he added one of the most critical issues comes down to transparency when understanding assumptions which sit behind an analysis related to pension risk or deficit. A good question for trustees to be asking their advisers, Mody said, is: “What is our funding deficit, and why is it calculated that way?”

Keep monitoring

Chris Ramsey, actuary and associate at consultancy Barnett Waddingham, said that schemes “should have a monitoring system in place” to keep an eye on the strength of the employer, investment risk and how well funded the scheme is. It is also important to have plans in place for when something unexpected, such as Brexit, crops up.

Ramsey said that it is important for trustees to “understand the impact of Brexit on the employer’s business”. It is also crucial to gauge how Brexit and market volatility has affected the scheme in terms of how much they now have to rely on the employer.  

Ultimately, Ramsey said schemes should not panic or make any knee-jerk reactions. However, he said many trustees over the past few years have assumed that the low gilt yield situation is temporary and will improve. “It hasn’t improved, in fact it’s got worse… this is not necessarily rock bottom”, as yields can fall further than they have already.

Revisiting risk

Shajahan Alam, ‎head of solutions research in AXA Investment Managers’ UK liability-driven investments team, said many schemes that have not hedged their liabilities have been “effectively relying on a big bet that interest rates will rise, so the decision not to hedge is basically driven, implicitly or explicitly, by a desire for interest rates to rise”.

“Given the current environment and what’s happened, it’s clear that that bet is not paying off and it hasn’t paid off for a long time,” Alam said.

For schemes, “it’s a matter of revisiting the risk that they have and taking a more diversified set of risks in their asset liability portfolio,” he said.

Tim Giles, head of UK investment consulting at Aon Hewitt, said trustees should be thinking about what has been the impact on the sponsor covenant with regard to market volatility caused by uncertainty such as Brexit.

However, he said that it is also "time to step back and think about the risks you've got within that pension scheme, and it may be that you don't want to continue to run them".