Defined benefit pensions could be seen as an opportunity for growth and improved outcomes delivering value for all stakeholders and wider UK plc, consulting firm LCP has argued, rather than being consigned to history.  

 

A high level of prudence within UK pensions will have largely protected scheme sponsors against possible new significant cash calls, but it can have unintended repercussions, LCP said in a new report aimed at corporate sponsors, ‘The cost of prudence to UK plc: Robust protection or missed opportunity?’ 

 

 

LCP said the huge shift in market conditions over 2022 means schemes taking a prudent approach “will have missed out on a golden opportunity to generate value for sponsors, for members, and for wider stakeholders. Schemes taking more risk will have benefitted with significant improvements in funding levels on all measures.” 

 

DB schemes of FTSE companies could have missed out on returns from not investing in higher risk assets, noting that investment in equities dropped by a third over 2022, from 14% down to 9%.  

 

DB schemes took a prudent approach following the market panic of last autumn, which required them to liquidate some assets, including equities, to maintain their liability-driven investment programmes. LCP estimates that the change in asset allocation might have “hit FTSE100 corporate balance sheets and pensions funding positions by around £10bn”.  

  

In reaction to last autumn’s crisis, pension funds were told in November last year to hold liquidity buffers of 300-400 basis points, up from the typical 100 bps; in April this year, the Pensions Regulator said pension funds should have an operational buffer for day-to-day volatility in normal conditions and liquidity for severe market stress so that yield moves of at least 250bps can be withstood. The buffers might have been needed in recent days, when yields for two-year gilts spiked even higher than last autumn, to close to 5%. 

 

Gordon Watchorn, who heads up corporate consulting at LCP, said prudent pension strategies largely worked as intended throughout the LDI crisis and limited risks of future cash calls on pension scheme sponsors, which has increased the security of DB pensions over recent years. 

 

However, “we are now at a point where schemes are looking to explore and implement different options to make the most of opportunities”, he claimed. 

 

Jonathan Griffith, partner and author of the report, believes DB pensions in the UK are at a crossroads.  

 

“They could be consigned to the history books as the rapid increase in insurance derisking takes hold, or could be seen as an opportunity for growth and improved outcomes delivering enhanced value for all stakeholders and wider UK plc,” he argued, seemingly pointing to the fact that pension investment in UK plc, promoted by the current government, can only be maintained if UK plc in turn maintains its pension funds. 

 

 

The consultancy also said schemes that were 100% hedged on an actuarial basis were overhedged on an accounting basis, meaning a rise in gilt yields would likely have had a negative effect on their IAS 19 funding position. The report argues that while the actuarial improvements among DB schemes are positive, “the potential worsening of corporate balance sheets could be a surprise for shareholders and wider readers of accounts”.  

 

The aggregate defined benefit IAS 19 surplus among FTSE 100 companies increased to around £67bn at the year-end, from £59bn at the beginning of 2022, according to the firm. The rise indicates average funding levels reached 120%, up from 110%. About 90% of FTSE 100 companies showed an accounting surplus in their UK DB pension plan. 

  

The funding positions for DB schemes improved by the end of May. Recent figures from the Pension Protection Fund show that the aggregate PPF funding level for the 5,131 schemes in its universe stood at 145.1% at the end of last month. 

 

 

Elsewhere, the report shows that about three in four FTSE100 chief executives are not receiving the same level of pension contributions as their employees. This is despite campaigning from the Investment Association for executive pensions to be more in line with the rest of the workforce. 

 

In 2020, the IA informed companies that its Institutional Voting Information Service would be giving a ‘red-top’, its highest level of warning, to companies that fail to draw up a credible action plan to align directors’ pension contributions by the end of 2022 if they are 15% of salary or more. It expected new executive directors to automatically join with a pension contribution aligned to the workforce rate.