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05

Half of DB pension schemes now cash flow negative

Open-access content Monday 5th June 2017

Some 55% of UK defined benefit (DB) pension schemes are now cash flow negative, up from 42% last year, according to Mercer’s European Asset Allocation Report 2017.

2

It reveals that 85% of the remaining schemes are expected to also be cash flow negative by 2027, lacking sufficient income from investments and contributions to pay member pensions, and often needing to sell assets to meet their liabilities.

Consequently, they are thought to be more vulnerable to market corrections since they might be forced to divest during a period of market stress, with more than 60% of the schemes found to be without a formal de-risking plan in place.

"Being cash flow negative is a natural life stage of a mature DB pension scheme, of course, but recent stock market performance may have lulled some into a false sense of security," Mercer global director of strategic research, Phil Edwards, said.

"Trustees of cash flow negative schemes need to be sure that, in the event of a large market correction, liquid assets are available to meet cash flow and collateral needs, without requiring the scheme to crystallise losses.

"We would encourage all schemes - large and small - to use scenario planning and stress-test analysis to understand how a market correction might impact their financial health."

The research is based on a survey of institutional investors, with 47% saying that their long-term funding objective was self-sufficiency, 36% focus on technical provisions liabilities and 17% are targeting buy-out.

In 2016, equity allocations fell as some schemes took opportunities to de-risk in the latter part of the year when equity markets and bond yields rose, with equity allocations averaging at 29% in 2017, compared to 31% in 2016.

It was also found that UK planned equity allocations have halved from 58% to 29% since 2008, with respondents expressing their intention to cut them further in the years ahead.

"There is a growing consensus that portfolios dominated by equities, credit and government bonds will offer a relatively unattractive risk/return trade-off in the future," Edwards continued.

"While hedge funds have faced a challenging post-crisis environment, with falling volatility reducing the potential for generating alpha, institutional investors have, in the main, retained their allocations in recognition of the valuable role they can play in portfolios."


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This article appeared in our May 2017 issue of The Actuary.
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