At a glance
- DB schemes could reduce the overall funding gap by looking into alternative solutions
- 5% of FTSE 350 company DB schemes could transfer to a consolidator with no cash injection
- Consolidation drive in DB means new end-game solutions are emerging
The funding gap across FTSE 350 schemes could be slashed by as much as £275bn if schemes look beyond traditional ways of creating value. Victoria Ticha examines how
The UK's overall defined benefit (DB) funding shortfall could be cut significantly if schemes employed a wider range of opportunities that create value for money, according to Hymans Robertson.
The consultancy has analysed the DB schemes of FTSE 350 companies, estimating that the total £500bn accounting deficit at the end of 2017 could be slashed by around £275bn. The remaining £225bn funding gap would then provide a much more realistic target for schemes to achieve and manage through investment returns and contributions, it found.
The report recommends schemes review their long-term objectives in light of this. For example, schemes could look into new opportunities in the consolidation, risk transfer and investment markets, which could create billions of pounds of additional value across the DB spectrum.
According to the consultancy, 'value' is often associated with minimising costs, but in reality finding value for money goes beyond that. With annual running costs between £6.5bn and £8.5bn, compared to a collective shortfall of £500bn, Hymans Robertson believes more needs to be done.
Speaking at a panel discussion on 11 September, the firm's head of trustee DB Susan McIlvogue said: "Value is often associated with reducing running costs but there's a danger that schemes focus on this area alone."
Instead, trustees and sponsors should look beyond their traditional options and explore a broad spectrum of opportunities to maximise value.
The funding gap
The study - based on data from its FTSE 350 2017 report - showed 5% of companies could transfer their scheme to a consolidator, and 3% could go to buyout, with no cash injection. A further 17% could transfer to a consolidator, and 13% could go to buyout, with less than one month's earnings. It also found that 14% of companies had at least one scheme that could benefit from moving to a master trust.
Hymans Robertson head of corporate DB, Alistair Russell-Smith, said: "Despite billions being paid into DB schemes, many are still facing a huge deficit. Companies that are simply relying on investment returns and contributions to reduce the deficit could remain on-risk for many years to come.
"With 75% of schemes already cashflow negative there is an urgent need to fill the funding gap, and this can only be done if schemes are open to thinking in a different way."
However, as pricing for both pensioner buy-ins and whole scheme buyouts has never been more attractive and demand from schemes at an all-time high, this could lead to demand outstripping supply.
According to Hymans Robertson partner Richard Wellard, there is already a cue of schemes in line for 2019 transactions. "Appetite is diminishing slightly, and the second half of 2018 is already seeing a hardening of pricing," he said. "While insurers will still be able to meet demand, they will do so with limited capacity - as the assets they need to back bulk annuities become increasingly scarce."
There is a very limited supply of illiquid, long-dated asset classes which can meet the market's demand, compounded by the limitations of Solvency II, said Wellard. Effectively, this means insurers are all "fishing in the same pond". How will insurers generate sufficient quantity of those assets in the future?
Emerging end-game solutions
According to Russell-Smith, "newly emerging 'end-game' solutions" could provide a suitable alternative or bridge to buyout for some. This includes non-insured risk transfers, which involve transferring a scheme's assets and liabilities to a DB master trusts. Two new DB consolidators - Clara Pensions and the Pension Superfund - are already working on coming into the market this year.
Another emerging solution is insured self-sufficiency - where an insurer works closely with a scheme to manage and invest its assets with a buyout in mind. The benefit of this approach is that the funding level required for this solution is a lower than what is required by a full buyout.
But according to Clara-Pensions chief actuarial officer Nick Johnson, while a significant majority could utilise consolidation now, it is important to consider "when do these options work?" and "what can the scheme afford to do now?"
It is also important to remember that consolidation is not the same as insurance. While "it is not a replacement for insurance", Johnson said consolidation does offer some level of protection for schemes who cannot afford the traditional end-game solution, and for whom such a solution is suitable.
He said: "Clara is not designed to compete with insurance… do not compare us to insurance, rather, the objective is to get schemes insured straight away."
There are other strategies to reduce deficits.
For example, McIlvogue said making more use of alternative investment strategies would help schemes achieve the same returns for less upfront capital.
"If trustees were to adopt more capital efficient strategies, schemes could significantly improve their resilience to risk and more affordably achieve a stable income to meet benefit payments," she said.
McIlvogue also pointed out the increase in demand for DB to defined contribution pension transfers in the wake of the freedoms, which has already seen around £50bn paid out of DB since their introduction.
"We've seen requests for transfer value quotations treble since 2015 and quadruple the number of transfers being paid out. If this trend was to continue, transfers and other member options could reduce the DB UK deficit by as much as £100bn."