Top five challenges facing DB schemes

While the rate of DB scheme closures has eased, there is no doubt they are in decline, facing a range of challenges:

1. The economic climate

Pension funds are still struggling with the aftermath of the financial crisis. While this is a familiar comment it is no less relevant. 

Trustees are grappling with fund deficits in an economic situation where unconventional monetary policy from governments and central banks continue to distort asset prices.

2. Finding inflation-linked assets

The profile of DB schemes is increasingly mature and maturing schemes typically have a lower tolerance for risk. 

Pension funds with this profile require increasing and stable cash flows to match their liabilities and they look to hedge liabilities through index-linked assets.

Historically index-linked gilts have been used to hedge liabilities, but yields have been decreasing and gilts have become more expensive. This has been compounded by the scarcity of these assets as issuance levels are well below the level of demand.

3. The move to alternatives

The lack of traditional inflation-linked assets has increased the appetite for alternative assets. Our survey showed a third of schemes (34 per cent) having diversified into commercial real estate and 23 per cent into infrastructure. 

While the government’s announcement last year on the new National Infrastructure Plan is welcome, the bigger issue remains making sure there is a strong pipeline of assets that are suitable investment vehicles for pension funds. 

4. Burdensome regulation

Proportionate regulation that supports a scheme-specific funding regime and generates innovative structures will help schemes meet the various tests they face. 

But overly prescriptive legislation can be lethal, especially in challenging economic circumstances.

The period of financial certainty underlines how important it is that the Pensions Regulator will use its new objective to allow employers and trustees more flexibility to work together to establish viable, long-term funding plans for DB schemes.

5. Looking further ahead

There is still significant uncertainty about how strong the economic recovery will be, both in the UK and globally. And it is the nature of this recovery that will determine when interest rates go up and when quantitative easing (QE) is tapered, stopped or reversed. 

We all know how pension funds were affected by the monetary policies adopted to manage the impact of the financial crisis, so it’s critical the Bank of England makes sure it minimises market volatility when unwinding QE. 

Private occupational pension schemes have existed since the mid-19th century and they have always had to adapt to survive and thrive. 

Today’s schemes are no different and continue to show creativity and determination in meeting both their challenges and obligations. 

But they need support to continue to do this – in particular a proportionate regulatory regime that enables flexibility and innovation and a monetary policy that understands the impact on pension schemes as institutional investors.

Ruth Meade is a senior researcher at the NAPF