A new risk report from PensionsFirst aims to shift the focus from overall deficit numbers to underlying risk in analysis of defined benefit (DB) pension schemes, and describes significant underlying risks which could drive deficit swings of billions of pounds over short time periods.

According to PensionsFirst’s new PF Risk Report, compiled using publicly disclosed data, the combined deficit across the FTSE100 sponsored DB schemes reduced by £11 billion to £43.5bn in October.

However, the report found a five per cent risk of the IAS19 deficit increasing by £25.4bn or more in November, and projected that such a swing is likely to occur at some point over the next 20 months.

According to the report, interest rate volatility is the largest risk factor, contributing £17.8bn to the IAS19 Value-at-Risk figure. Equity risk contributed £15.39bn, and inflation £13.75bn. The report also focuses on inflation, foreign exchange, credit and property risk exposures.

Commenting on the findings, PensionsFirst Analytics chief executive Benjamin Reid said that the focus has been on scheme deficits in recent years, but the report showed that the issue of the underlying risk that drives volatility in schemes is far more important.

“This is a serious issue for all stakeholders – including pension scheme members and shareholders – because unhedged pension liabilities can result in significant exposure to market-directional risk.

“These are not wild predictions, but realistic scenarios, which is why we believe that simply looking at a pension scheme’s deficit number is inadequate. Instead the analysis needs to go much deeper – looking at the key drivers and the extent to which they could change the deficit. By publishing this report, which is derived from individual scheme analysis, we hope to draw greater attention to volatility and the management of risk,” Reid said.

PensionsFirst chief executive Timothy Lyons said that the majority of DB schemes’ risk can be effectively hedged, in particular the substantial risk posed by movements in interest rates and inflation.

However, the report does not seek to advise on the particular hedging or asset allocation strategies of schemes, rather it aims to bring the issue of risk closer to the forefront of debate around DB schemes.

“The report is not prescriptive, it doesn’t tell you what you should do. It’s there to raise a debate, and make people think about what the drivers of risk are, and what the real impacts of different investment strategies and investment classes are on risk,” Lyons said.

This PF Risk Report is the first in what will be a monthly analytical report on UK DB pension risk across FTSE100 sponsored schemes. The reports, presented as an interactive online tool, will offer a forward-looking view of the pension assets and liabilities held by the UK’s largest companies, and aim to reveal the likelihood and magnitude of future deterioration or improvements in the FTSE100 pension schemes funding position.
Reports will be updated monthly, and will be accompanied by a commentary of market movements over the month.

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