The European Insurance and Occupational Pensions Authority (“EIOPA”) released the results of their Europe wide Occupational Pensions Stress Test last week.
The results show that pension scheme deficits can have a detrimental impact on the economy as a whole when companies’ future growth prospects are restricted by the level of contributions that they need to pay to schemes to plug their deficits. Businesses can fail as a result, bringing unemployment.
In this situation, it is also likely that members will not receive their full benefit entitlement in retirement.
What do the results of the stress test tell us?
The UK was one of three countries that showed a funding deficit on their current funding basis. It was also the worst performing country when measured using EIOPA’s common balance sheet approach, a method that broadly measures the ability of the scheme to sustain itself. The UK also fared the worst under the stressed scenario. This showed a funding level of just 45% for UK schemes.
EIOPA estimates that sponsors would only be able to cover 80%-90% of this deficit, meaning that the remaining 10%-20% of the deficit would fall on the PPF and the reductions in the level of benefits that members receive under the PPF than their scheme.
The report also highlighted the size of deficits relative to scheme sponsors. For 25% of schemes, the estimate of value of contributions required by the sponsor in the balance sheet exceeds 42% of the sponsors’ market value. This rises to 66% when the stresses are applied. For many schemes, the value placed on sponsor support in the balance sheet is greater than the sponsors’ market value as a business.
Such high level of contributions required would likely place a huge strain on scheme sponsors. This could affect their ability to continue to trade and when considered on a national basis could have a detrimental impact on economic growth and employment.
How do we plug this deficit?
There is no magic solution to fixing the UK’s pension funding shortfall. It will likely be a long process that will take into account a number of factors including scheme funding, investment and sponsor covenant within an integrated risk management framework.
The most important of these factors is to ensure that the trustee board has the expertise to be able to monitor and understand the funding position of the scheme.
There are a number of key take-away points for trustees:
- Ensure that you monitor your scheme’s funding level closely. These can be used to enhance your understanding of your scheme’s funding volatility.
- Trustees should work closely with the sponsors of their schemes to develop funding plans that will ensure the security of members’ benefits and minimise the impact on the sponsors business.
- It is important to take care when setting and reviewing your scheme’s investment strategy. Techniques such as stress testing and stochastic modelling can be used to assess how robust the strategy is under adverse market conditions.
- Make sure to review governance procedures regularly to ensure that decision making is effective and allows the scheme to react quickly to a volatile and changing market.
- Trustees can consider other options to secure members’ benefits such as securing benefits with an insurance company. Alternatively, they can look at options that can provide members more flexibility to take their benefits whilst removing risk from the scheme. This may include giving members the option to transfer their benefits prior to retirement so they can avail of flexible drawdown options.
The past few weeks have seen many interesting changes in investment markets as they attempt to find a new level following Brexit. Pension Schemes should take this into account when reviewing their funding and investment strategies. In some cases it may be worthwhile to expedite your investment review, although as pointed out by my colleagues, this will only be in exceptional circumstances as pension scheme investments will be based over a very long horizon.
We will look at some of the major changes that have happened to markets since the EU referendum, consider how these will impact Defined Benefit (“DB”) schemes and provide ideas to help manage risks caused by the resulting market volatility over the coming months. Read more »
Here we are, at the end of Q2 and Spence are pleased to be publishing our topical round up of developments over the last three months with time saving summaries, helpful links to papers and blogs and action points for Employers and Trustees to consider. It’s an essential tool for Employers and Trustees who need to keep up to date with developments that affect them and their schemes. Highlights for this quarter include:
- A brief summary of George Osbornes 2016 Budget
- An outline of the new Lifetime ISA
- How might the Brexit Referendum affect schemes?
- Notwithstanding Brexit what has been happening in Europe and what will it mean for schemes?
- Important changes for Corporate trustees: Persons with Significant Control Regime
We love to get feedback and constructive criticism. If you like what we do please tell us, it’s nice to get great feedback. If you would like things included, excluded or done differently please drop us a line. The report is to help you so help us tailor it to your needs.
Download your Quarterly Update here
Nothing ever slows down in the world of pensions, from the launch of FRS102 to the end of contracting out, there’s a lot going on.
So, to help keep you in the loop we’ve been monitoring industry changes and trends from the last quarter and condensed the information into a snappy report for you to download. This update briefly summarises everything you need to know, and clearly sets out the actions you need to take. Saving you hours of scouring through multiple reports, press releases, blogs and articles.
Some key updates to keep an eye out for are:
- A summary of the Chancellor’s Autumn Statement
- How the upcoming changes to LTA and AA will affect you
- An update on the effect of Pension freedoms so far and the introduction of a Secondary Annuity Market in the future
- Changes to the PPF levy determination for 2016/2017
Download your Pension Quarterly Update here.
Following the recent investigation by Friends of the Earth Scotland which found that the Scottish Parliament pension fund invests £3.2 million of its funds into tobacco, weapons and fossil fuels, I began to think about socially responsible investment and how it can impact pension funds.
I’ve always been quite sceptical about ethical investment for a number of reasons, mainly the question “What is ethical investment?” It’s a very subjective question, and many people will draw a different line about what they consider to be ethical or unethical. Tobacco was one of the sectors mentioned by Friends of the Earth Scotland in their investigation; it’s easy to see how different people can be on either side of the argument. There’s also the issue that restricting investment in these sectors prevents a fund from investing in a number of well established and stable companies – it seems that this would be detrimental to the performance of the fund. However… Read more »