DB schemes near buyout may be exposed to excessive risk

Defined benefit pension schemes approaching buyout may be exposed to unnecessary risk due to Brexit uncertainty and the global economic slowdown, according to Barnett Waddingham.

The consultant has said that too many DB schemes are over-exposed to growth assets at a time of continued volatility and could, as a result, end up jeopardising their ability to secure a buyout contract. Its warning comes after the FTSE 100 hit a six-month low in August.

Barnett Waddingham expects firms looking to buyout within two years to typically hold 10 per cent to 15 per cent, or less, in growth assets. Those who are looking to buyout within a two to five-year period should, it says, hold no more than 15 per cent to 25 per cent in growth-seeking investments.

Of the FTSE 350 companies who may be able to buyout in the next five years, on average at least 27 per cent of their DB pension scheme assets are invested in growth assets, including 11 per cent in equities, which Barnett Waddingham describes as an “aggressive” allocation. A further 12 per cent sits in diversified growth funds, which are also exposed to changes in equity markets.

Researchers at the company have calculated that one in five schemes that could be in a position to buyout in the next five years have growth allocations of over 50 per cent.

This over-exposure comes at a time when DB schemes’ funding positions continue to be threatened by long-term interest rates falling. The consultant argues that schemes can do more to neutralise the impact of lowers global bond yields and reduce the volatility of their funding levels.

Overexposure to growth assets, particularly illiquid investments, may also cause cashflow issues. Ninety per cent of schemes are already cashflow negative, and one in eight FTSE 350 schemes have a cashflow burden above five per cent of total assets.

If cashflow is not adequately managed, Barnet Waddingham has warned that schemes could find themselves needing to sell down assets to meet liabilities at a time when asset valuations may be falling. This is especially true given the perception that many asset classes are over-priced at the moment. These forced sellers would likely move further from the ultimate goal of a buyout.

Barnett Waddingham head of corporate consulting and partner, Nick Griggs, said there is no room for complacency when it comes to managing risk in a DB scheme, especially with the possibility of a global economic slowdown, Brexit, and the trade wars potentially creating a perfect storm which threatens financial markets.

“Without careful management, schemes sponsors may suddenly find their DB scheme a lot further from a buyout than they envisioned,” he warned.

“As schemes have matured, a general de-risking has been inevitable, but corporates need to seriously consider whether they have gone far enough. Especially for those close to the endgame, being proactive with your strategy is crucial in ensuring the level of investment risk matches the agreed objective, whether that’s an insurance company buyout or a run-off.”

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