In its white paper Vision 2020, the SPC said the trend towards schemes de-risking meant that the bulk of the collective £1 trillion assets of UK DB schemes will be moved from equities to bonds by 2020.

DB liabilities currently amount to 155% of the sterling investment-grade bond market and 274% of the long-dated bond market. If 60% of these liabilities were linked into inflation, they would account for over 400% of the long-dated inflation-linked bond market.

If schemes do choose to fund their liabilities and deficit contributions by investing in bonds, their demand could therefore amount to 12% of the overall market every year. In particular, they could require up to 35% of the long-dated inflation-protected bond market.

‘Clearly these are unfeasible numbers,’ the SPC said. ‘If pension schemes continue to de-risk without taking a step back and considering the implications of this excess demand, the extremely poor value in long-dated bonds will not improve and could even get worse.’

The SPC explained that excess demand would drive bond prices up and yields down, increasing the value of pension liabilities. This then causes a vicious circle where higher liabilities increase scheme deficits which then require schemes to invest more in bonds, which in turn further reduces the yield on bonds that schemes use to calculate their liabilities.

‘This directly impacts on UK Plc, which ultimately has to find the deficits emerging,’ the report said. ‘The tail is only caught once these schemes are all funded and invested on a bond basis at great expense.’

Sponsors should therefore consider alternative ways of de-risking their pension scheme, with infrastructure, property and the derivative market among the other avenues they can use to secure inflation-linked cash flows to match their liabilities.

In particular, the SPC said government should review valuation methodologies to recognise the liability matching characteristics of infrastructure or property ‘cash flow’ assets.

Pension schemes’ requirements should also be considered in future regulation and in how large infrastructure projects are structured and funded, while tax structures should support pension funds investing in derivative markets.