Against a backdrop of deepening crisis that continues to cause severe strains to economies worldwide, Royal Mail Pensions Trustees chief executive Gerry Degaute says there is little to be happy about for UK pension schemes.
He says that while defined benefit and defined contribution schemes might have challenges of a different nature, both need to tackle a range of issues over the years to come.
Facing up to the problems
Degaute says the deterioration of funding levels is the biggest challenge for DB schemes. He says: "We have several damaged corporate sponsors - obviously worse in some sectors than others. This implies the ability of plan sponsors to meet the commitment of pension plans is under pressure.
"In many cases these pension plans are not fully funded, so the corporates not only have to find the money to fund the future service costs but also to meet any contribution required under any deficit or recovery plan."
According to Degaute, trustees will need to take the situation of the corporate sponsor into account - implying trustees need to have tolerance and not drive these companies to meet unaffordable contributions in the current economic climate.
Indeed, he adds that the impact for DB schemes has been that the employer's ability to meet the obligations has been severely tested and the plans themselves, at this stage, have larger deficits driven by the downturns in asset markets and falling yields which, in turn, have driven up the value of liabilities.
In contrast, Degaute finds the biggest challenge for DC schemes is the provision of appropriate investment strategies and planning tools to help them save for the future.
He says: "Many of these DC plans are quite immature and several members might be looking at pots whose value is less than the contributions they have paid in. How is that going to make them feel about investing for the future?"
On the macroeconomic level, Degaute says that the actions taken to counteract deflation, notably quantitative easing, would lead to inflation in the longer term - potentially to levels unseen in the recent past.
He explained: "We have lived in a quite long era of controlled inflation where central banks have been given a remit by governments to control inflation and they have had a good track record in doing so over the last ten or 20 years.
"We have not had - in the UK certainly and maybe in the other major economies - a period of hyperinflation like that of the seventies when we saw in some cases monthly pay increases to counteract the effects of inflation."
What particularly concerns Degaute is the fact the current crisis leaves many question marks - as it is not comparable to previous financial crises.
He points out: "All previous stock market reverses in my lifetime have been a correction of a market becoming too inflated, while this is the first time that it has been caused by a bubble in a different area. It was a credit bubble that knocked onto the stock market, the corporates and now the real economy."
He says the linkage between investment and funding has never been as close as it is now - and notes that, as a result, a large number of investment strategies are about managing liability risk, with the challenge being how to find enough appropriate and reasonably priced investments that can help pension plans manage liability risk.
Overcome the challenges
Degaute does not consider it unreasonable to expect good investment conditions to return in the short term and calls for pension funds "to be patient" for the equity returns to come back and contribute to easing schemes' funding problems.
Equally he considers it totally understandable if trustees and plan sponsors wish to take the risk off the table and fully embrace a liability-driven investment strategy.
However, he warns: "We have to be very careful with the situation of plan sponsors and avoid a tough situation becoming a terminal situation.
"Therefore, we should think very hard before insisting that a plan sponsor is obliged to fill a funding gap in what might prove to be too short a period for it to afford."
The DC side has a different set of issues due to the fact the challenges in this area are faced by individuals.
Here, Degaute sees a problem looming as investors in DC schemes have become very risk adverse, as a result of the heavy losses posted by their investments.
He says: "Risk aversion might put the average DC investor into low returning vehicles that have security of capital as the main characteristic. The price of having security of capital means that the now risk-averse investors will not be placing their money in those investment markets, like the equity one, which is expected to give the higher returns.
"This means you either have to put more contribution in, you have to recognise you have a smaller pot to buy your pension from, or have to work longer to make the pot bigger.
"There is a job for those responsible for these schemes to make members aware of their options and the potential downside of being overly risk averse in the way I have described."
He adds: "This is causing a massive burden for DC schemes in terms of governance and education of members. In respect of trust or contract model being used, it is essential there is robust governance in place to protect the individual."
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