| UK pension schemes face heightened risk |
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| 24/03/2008 | |
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Risks associated with UK pension schemes are on the rise. In particular, regulatory changes that could impact plan funding seem to worry corporate officers the most. The findings are based on an Economics Intelligence Unit (EIU) survey covering 206 UK corporate participants. Two-thirds of the respondents believe that the risks faced by their schemes have increased compared to just one in ten who say they have decreased. "A perfect storm of volatile market conditions, stringent new rules and demographic change has created unprecedented uncertainty over pension provision." Forty-eight percent of respondents cite regulatory changes as a key risk. Not far behind (47%) are mortality assumptions, followed by equity volatility (40%). Separately, respondents were asked to identify aspects of their scheme management that they are keen to improve. Forty-two percent say understanding of funding options is a key priority. Expect more contributions Changes in accounting rules now force assets held as long-term investments to be valued at market prices. As a result, during market downturns, pension schemes risk being under-funded, requiring contributions from the sponsor. Four in 10 respondents believe that company contributions will be necessary in the next three years. "On occasion, trustee boards have even asked for schemes to be funded to insurance buyout levels that are significantly higher than a fully funded ongoing scheme. Although they have little chance of succeeding, at least the trustee board's minutes will record an attempt to extract the maximum contributions from the scheme sponsor." The second taxing issue is predicting longevity and its rate of increase. The risk of 75-year-olds living just a year longer adds significantly to a scheme's liabilities, negating an aggressive investment strategy that has been put into place to increase returns. "The Holy Grail is to develop products that hedge out mortality risk, and several investment banks are working on it, but as yet such a financial instrument does not exist." Equity volatility is cited as the third greatest risk confronting retirement schemes. Although schemes on average reduced their equity allocations during and following the 2000-20003 market downturn, one in ten still have an 80% allocation to the asset class in their portfolio, according to the EIU. Little used LDI Participants cite other areas of weakness such as performance management of trustees and investment consultants. "Many companies, it seems, have difficulties in determining the metrics that apply to their scheme, and in conducting performance management based on outcomes." The findings also show that, unlike their Dutch counterparts, more innovative investment strategies have yet to be employed by UK pension plans. These include the use of liability-driven investing (LDI) and derivatives to hedge against interest rate volatility. Only 14% say that they already have an LDI-driven approach in place and just 17% use derivatives to hedge interest rate and inflation risk. However, appetite to use them is strong, with 41% planning to use LDI investment in the next three years and 39% intending to make use of derivatives. There is also a strong desire to use annuity buy-outs, with 60% saying they would transfer at least some of their liabilities if they could do so at a competitive price. The main barrier is the reluctance of trustees to support such deals due to fears that the insurer (the third party) could fail to meet its obligations. In reality only 19% say they will actually transfer some of their liabilities to an insurance company. VB |
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