Defined benefit pension schemes across the UK struggled with soaring liabilities in 2015, but industry experts have warned against a 2016 ‘bet on interest rates’ in what could be a bumper year for tackling risk.
2015 brought bad tidings for UK pension schemes; FTSE 100 companies paid £6.3bn in deficit contributions in the year to June, only to see deficits deteriorate £19bn and liabilities rise £37bn over the same period.
The US Federal Reserve’s decision to raise interest rates last month may have renewed hopes for some respite from the Bank of England, but a UK rate rise is not anticipated before the end of this year.
‘Press on’ for risk transfer
Regardless of beliefs about movements in interest rates, schemes should continue to assess options for tackling liabilities through buyouts, buy-ins, liability-driven investment strategies and management exercises, said Charles Cowling, managing director at consultancy JLT Employee Benefits.
There needs to be a continued and increasing emphasis on settlement of liabilities
Charles Cowling, JLT Employee Benefits
“It’s not really for pension schemes to take a punt on interest rates,” he said. “You are effectively betting against the market.”
Schemes nearing the end of their recovery plan should “press on” towards buyout and work through the significant data and legal tasks required ahead of the transaction, said Cowling.
Small steps to manage liabilities along the road to buyout can be powerful for schemes seeking additional security amid market uncertainty, he added.
“I’m encouraging trustees and corporate clients to assess transfer values for people over age 55. [A] sufficiently generous offer will allow you take liability off the books below buyout,” he said.
“There needs to be a continued and increasing emphasis on settlement of liabilities.”
Insurance market shifts
2016 could be a bumper year for pension risk transfer. The bulk annuity market has surpassed £10bn over the last 12 months, according to consultancy Aon Hewitt’s latest risk settlement update.
Dominic Grimley, bulk annuity lead in Aon Hewitt’s risk settlement group, said favourable pricing was a major driver behind the dramatic upsurge in medically underwritten deals seen during the second half of 2015.
But full buyout will be a difficult hurdle to overcome this year, Grimley said. Low yields are forcing many schemes to retain growth assets and insurers have been eyeing Solvency II requirements kicking in from January 1.
From that date, pricing for non-pensioner buyouts could increase by up to 10 per cent, said Grimley, with a reversion later in the year.
LDI will be simpler
Pension schemes wanting to derisk through LDI are also faced with the interest rate issue. Jonathan Crowther, head of the UK LDI team at Axa Investment Managers, said any escape from the “shackles” will be long and gradual.
Crowther said using LDI with credit and corporate bonds to generate income will help maturing schemes to meet payments when they fall due.
“It’s moving from LDI version one – sensitivity hedging, making sure you’re protected against movements in interest rate and inflation – [to a] second generation of LDI, where you need to be able to continue to do that, but then also think about how you actually manage cash flow delivery in the near term more efficiently,” he said.
Rupert Brindley, pensions advisory and solutions managing director at JPMorgan Asset Management, said 2016 will be the year of simplification across LDI strategies.
“Looking for substitute asset classes is really going to be the major focus for next year because core LDI is becoming a luxury asset class,” said Brindley, also citing corporate bonds as one such asset class.
For derivatives-focussed LDI, incoming regulation on over the counter derivatives will be “net-net a negative”, he added.
Brindley said investors should seek longer-term “put-it-to-bed options” as opposed to conventional and more expensive hedging and offsets, which require a higher degree of ongoing management.
