Despite a challenging year, the lifeboat fund has weathered the storm with strong returns and an improved funding level. Stephanie Baxter analyses its annual report
The Pension Protection Fund (PPF) has stayed resilient in the face of the political and economic uncertainty of the past year.
According to its annual report, the lifeboat fund ended the 2016/2017 financial year in a robust position - increasing its funding level by four percentage points and benefitting from an extra £2.1bn in reserves.
Its funding rose from 116.3% in March 2016 to 121.6% in March 2017, while reserves increased from £4.1bn to £6.1bn - driven by strong investment performance and lower than expected claims. The value of new claims from schemes entering PPF assessment fell from £476m to just £252m.
There was no change in the PPF's probability of reaching self-sufficiency by 2030, which is 93% just as the previous year. This is based on its long-term risk model, which calculates the impact of one million economic scenarios on the fund's probability of success.
Although the £6.1bn reserve acts as a buffer to help the PPF to meet future claims, it is just 5% of what the PPF is underwriting, and small compared to the £226.5bn net deficit of all 7800 schemes reported at the end of March.
Some 62 schemes transferred over the course of the year, almost double that in the previous financial year, bringing in new assets of £1.3bn. As of March 2017, a total of 894 schemes have transferred to the lifeboat fund, while another 103 schemes were in PPF assessment representing £6.1bn of total liabilities.
It collected £585m in levies - a slight rise from £558m the previous year, while PPF compensation paid to date increased from £2.4bn to £3bn. Operating costs rose from £55.4m to £60.4m.
Speaking to PP, chief financial officer Andy Mckinnon says: "We've maintained good performance, and continued to keep ourselves in a strong position to face continuing uncertainty."
The PPF enjoyed high average returns of 16% across its investment portfolios, a substantial increase from just 1.7% in the previous year (although far below the 25.9% it achieved in 2014/2015).
According to McKinnon this was driven by the PPF's hedging programme, which invests in government bonds and uses some derivatives, as well as its growth portfolio which performed very well, contributing £1bn returns.
"We exceeded targets for growth assets, which are managed against a fairly low-risk investment strategy," he says.
The investment growth portfolio returned 3.9% for the year, above the PPF's stated objective of 1.8% above Libor, and its target to achieve this on a rolling three-year basis was exceeded by 1% annually.
The asset classes that contributed the most were alternative credit, which generated 11.75% return and minimum variance equities with 12.33%.
It comes as the PPF has insourced a significant part of its liability-driven investment (LDI) programme, and successfully completed the second phase of that project over the course of the year. Since fund management fees represent the largest proportion of the PPF's costs, insourcing brings significant cost saving benefits.
McKinnon says bringing investment in-house also "gives us more control over what we do" and "we're better able to react what's going on in the market".
"The majority of the LDI is now invested in-house, so most of the risk we're protecting ourselves against is managed internally. The growth side is invested through third-party managers and over the next two to three years we'll look at how to expand on our LDI capability to broaden it out to other asset classes."
It plans to insource cash, foreign exchange and certain elements of the credit portfolio, but says it will only bring investment in-house where it believes it can improve performance compared to external fund managers.
Although the lifeboat fund has weathered the storm this year, there are further challenges on horizon, not least Brexit.
"We look at every possible economic scenario. It will be difficult to plan for exactly what Brexit will mean, how it will be implemented and what it will mean for the UK economy and global economy," he says.
"In these very uncertain times, and a very uncertain economic environment, it's important to recognise there are a lot of people and money still in DB, so what we do to protect is very important," he adds.
It is also considering what regulatory requirements for central clearing and bilateral margining of over-the counter derivatives will mean for its investment operations. As a larger cash reserve will be needed to account for potential rapid changes in associated margin payments, it may have to change its asset allocation.
On a wider level, the PPF has a difficult balancing act in years to come as the number of levy-payers reduces along with levy revenue at the same time as more schemes and members enter the PPF. Therefore, the investment portfolio will play an ever important role in ensuring the PPF can protect itself, the members and levy-payers.
McKinnon says: "Over time, the more resilient balance sheet will continue to contribute more through the investment returns and we'll become less and less dependent on the levy which is commensurate with a smaller population."
The PPF's report has been generally welcomed by the industry. However the Pensions and Lifetime Savings Association's (PLSA) head of governance and investment Joe Dabrowski notes: "It is important that the PPF remains strong given the significant amount of risk that still exists in the DB sector. However, schemes will be looking at these results with an eye on their levies and expect the PPF to continue, or accelerate, the downward trend in the overall quantum."
Lincoln Pensions chief executive officer Darren Redmayne also says the PPF appears to be in "decent shape" and "it is encouraging to see the progress that it has made." However, he warns the lifeboat boat is "not out of the woods yet" given the size of DB deficits.
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