Fresh investment strategies are needed if mature defined benefit (DB) schemes want to pay benefits to members on time according to Legal and General Investment Management (LGIM).
The firm's head of research Paul Sweeting (pictured above) argued in a paper that schemes need to reconsider how they measure success in order to design appropriate asset allocation.
He urged funds to take action given they are increasingly focused on being able to pay accrued benefits rather than allowing new members to join.
This comes as many schemes are closing to new members and future accrual, and concerns that some may become cashflow negative in the near future.
Sweeting introduced a measure that is very different to traditional funding valuations where schemes just look at the market value of assets in relation to liabilities.
His measure called ‘chance of ultimate excess' (CUE) looks at the cashflows generated by the scheme assets and the extent to which they could meet liabilities.
Sweeting said: "What we are looking at here is a pension scheme which is not going to be closed down, it is just going to close its doors [to new members and future accrual]. The question here is do we have enough to pay when the pensions money is due?"
The initial level of assets relative to liabilities, and the way in which those assets are invested were the two factors in deciding whether a scheme hits CUE.
LGIM found schemes with a funding level of over 85% on a gilts basis had more than a 90% chance of meeting their liability cashflows. "If a scheme's funding level drops below 85%, its chance of meeting CUE falls rapidly. This happens because below a critical level of funding, it becomes impossible for a corporate bond portfolio to meet the liability cashflows, even with no losses from defaults or downgrades," the paper said.
It also found schemes are more likely to pay their members by relying on corporate bonds instead of government bonds if CUE was the primary metric being used.
However, Sweeting warned CUE must be seen as "complementary" to other aspects of the investment strategy, and should not be the only tool schemes use.
The paper is called Endgame porfolios and the role of credit: Cue new thinking for self-sufficiency.
In this live blog, Professional Pensions' sister title Investment Week collates all the breaking market news, analysis and opinion on equity, bond and currency movements as well as the impact of trade wars, tightening monetary policy and the Brexit negotiations....
Ross Trustees has secured investment backing from private equity investor LDC, as it prepares to capitalise on growing demand for professional trustee services.
Lee Sanders says the fast and adaptive market response to the crisis of 2020 has shown how much the financial system has improved upon the credit market liquidity issues that were at the heart of the 2008 global financial crisis (GFC).
Defined benefit (DB) schemes that provide GMPs must revisit and, where necessary, top-up historic cash equivalent transfer values (CETVs) that have been calculated on an unequal basis, a landmark court judgment said last week.