Pension schemes have been “shoehorned” into valuing liabilities against gilts, creating a “herd mentality” that does not reflect scheme funding accurately, says PwC.
Any change to the defined benefit (DB) funding regime should therefore refrain from tying parameters to gilts and instead focus on scheme cashflow obligations, the firm said.
Responding to The Pensions Regulator's (TPR) consultation on the principles to underly the proposed DB funding code, PwC said ditching gilts as a benchmark could open up £40bn of extra value.
The consultancy has now urged the watchdog to recognise in the funding regime that schemes can back pension commitments with a diversified portfolio of cashflow-matching bonds and low-risk income-generating investments outside of the gilt arena.
Global head of pensions Raj Mody said: "The pensions industry has been shoehorned into an undue focus on referencing everything back to gilts, as a so-called risk-free benchmark. While that doesn't stop individual schemes doing their own thing, the trouble with this kind of reference point is that it creates a herd mentality. This then puts pressure on trustees or companies looking to follow a more bespoke approach, even if it's a better strategy for their own pension scheme."
Throughout the last decade, scheme investments in gilts nearly doubled from 23% to 45% of assets, while the proportion of pension funds related to paying current pensioners is 40%. PwC said this demonstrated that there was a drift towards using gilts, partly as a result of gilt-based rules and regulations, even if this may not necessarily be the optimal solution for all pension funds.
The regulator should refrain from underpinning the future funding framework with gilts, instead ensuring the parameters remain flexible enough to allow a focus on the future cashflow obligations of pension funds and the best assets to match those.
By not focusing on a "single-point valuation" and comparing liabilities to a "single-point asset number", extra value can be unlocked to benefit pension schemes and facilitate more diverse investment strategies, the consultancy said.
Mody said previous funding regimes, including the Minimum Funding Requirement, recognised the need to treat funding of existing pensioner liabilities differently.
"If anything, the need for something like this is now more acute. Pension schemes are now doing exactly what they exist for - to pay out retirement incomes. But that makes it all the more important to get the new funding framework right, both for existing and future pensioners."
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