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New approach to DB pension funding could generate £40bn

Open-access content Wednesday 23rd September 2020
New approach to DB pension funding could generate £40bn

A more contemporary approach to how liabilities for UK defined benefit (DB) pension schemes are funded could generate £40bn in extra value, PricewaterhouseCoopers (PwC) has found.

The improvement would come from avoiding pensioner liabilities being too closely tied purely to gilt investments, which have increased from 23% to 45% of DB schemes' assets over the last decade.

Instead, PwC said that the real need for pension schemes is to match annual outgoing cashflows each year as they pay pensions, which could be supported with a diversified portfolio of cashflow-matching bonds and other low-risk income-generating investments.

“The pensions industry has been shoe-horned into an undue focus on referencing everything back to gilts, as a so-called risk-free benchmark,” said PwC's global head of pensions, Raj Mody.

“While that doesn’t stop individual schemes doing their own thing, the trouble with this kind of reference point is that it creates a herd mentality. This then puts pressure on trustees or companies looking to follow a more bespoke approach, even if it’s a better strategy for their own pension scheme.”

The Pensions Regulator (TPR) has opened a consultation to review how it regulates the funding of DB pension schemes, and first-stage responses were submitted earlier this month.

PwC said that the parameters underpinning any new funding regime should be flexible enough to avoid a need for pension schemes to back their pensioner liabilities with gilts. 

Instead, the firm believes that forward-looking parameters should focus on the cashflow obligations of pension funds, with flexibility to find the best assets to meet those cashflows, instead of focusing on a single-point valuation of the liabilities and comparing those to a single-point asset number. 

“Even previous funding regimes have recognised the need to treat the funding of existing pensioner liabilities with caution,” Mody continued. “The minimum funding requirement introduced in 1997 had a special concession for valuing large groups of pensioners.

“If anything, the need for something like this is now more acute. Pension schemes are now doing exactly what they exist for – to pay out retirement incomes. But that makes it all the more important to get the new funding framework right, both for existing and future pensioners.”

 

Image credit: iStock

Author: Chris Seekings

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