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The Actuary The magazine of the Institute & Faculty of Actuaries
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DB schemes no longer poisoned chalice for investors

A white paper launched today by PSTS, the transactions consulting division within Punter Southall, asks whether widespread investor fear now presents a golden opportunity to those investors who fully understand the existing defined benefit (DB) pension scheme environment.

The firm says that experience for pension schemes has been a true 'pensions apocalypse' with deficits continually increasing despite ever greater deficit correction payments and that the majority of investors perceive an investment in a company with a DB scheme to be a "poisoned chalice".

The report details four key obstacles (or horsemen of the Pension Apocalypse) that have faced DB pension funds over the last 15 years, and identifies how each of these might now present an opportunity for investors.

Richard Jones, managing director of Punter Southall Transaction Services, said: "The four horsemen, detailed in the report, are clearly on the wane and much less likely to be negative factors going forward. Indeed there is room for significant optimism that they could start to drive improvements in the funding position of pension schemes. For even the most risk averse, innovative solutions now exist to mitigate any perceived risk.

The four 'horsemen' detailed are:

Famine

Obstacle: Equities remain the most important asset for a defined benefit scheme. The first decade of this century saw the worst equity performance relative to bonds since the 1930s.
Opportunity: Market conditions are currently much more favourable for equity investment going forward such that it is not an unreasonable expectation that equities will out-perform bonds significantly in the future as they have done for most historical periods. For the short-term investor any significant volatility in the equity markets is muted. It is unlikely that the valuation of the pension scheme will be crystallised when equity markets are severely depressed, principally due to the correlation between equity market conditions and merger and acquisition activity.

War
Obstacle: Successive governmental intervention has increased the security of the defined benefit pension scheme. The consequence being that a ‘best endeavours' undertaking has now become an inescapable legal obligation.
Opportunity: Pension schemes now have such a degree of protection that it is almost impossible to see where the Government could tighten the existing regulations further. Government has begun to recognise that excessive regulation has strangled pension schemes and their sponsors and have made some concessions to redress the balance such as the recent change from RPI to CPI indexation.

Pestilence
Obstacle: Most funding measures are driven by bond yields. Since 1997 the real yield on government bonds has steadily fallen from 3.5% per annum to the current low of 0.5% per annum.
Opportunity: Continued falls in real yields. The real yield of index linked government bonds has fallen to a record low of around 0.5% per annum. There is nowhere further downwards for the real yield to go.

Death
Obstacle: Or more accurately, lack of it. Longevity has improved over the last 15 years and has impacted pension scheme liabilities by around 30% through more accurate experience and allowances for future improvements.
Opportunity: Mortality modelling and forecasting has improved dramatically and pension scheme liabilities now fully reflect current observations and future expectations. The potential risk in mortality estimation is now evenly balanced and the potential for negative consequences is much reduced.