UK DB pension deficit could be eliminated via funding and investment changes

A shift in pension funding and investment strategies could eliminate the UK’s current £190bn defined benefit (DB) pension deficit, analysis from PwC has found.

The findings come amid the latest PwC Pension Funding Index update, which showed that volatility in the markets, including equity market surges and a slight increase in government bond yields, combined to reduce the deficit to £190bn at the end of November.

This represents a £70bn fall from the £260bn deficit recorded in October, and the lowest level since the onset of the UK’s first lockdown.

PwC has also introduced an Adjusted Funding Index for this first time this month, which incorporates two strategic changes that it stated should be available for most pension funds backed by viable companies.

These were a shift towards higher-return cashflow-generating assets instead of gilts, and a deferred approach for funding very long-term potential life expectancy improvements which have not yet happened.

The company emphasised that using this Adjusted Funding Index would eliminate the £190bn aggregate deficit, therefore illustrating the opportunity for pension schemes to consider new approaches.

In particular, it found that this approach would push liability values from £1,990bn to £1,790bn, wiping out the current £190bn deficit.

PwC global head of pensions, Raj Mody, commented: “Most pension fund trustees and sponsors have become conditioned to a world where there is always a funding deficit.

“The Adjusted Funding Index illustrates that it doesn't have to be that way. You would hope that after years of paying in cash to pension schemes to repair deficits, then eventually that plan would have worked out.

“Trustees and sponsors should review their strategy and deficit assessment afresh, without being tied to historic approaches or assumptions which may now be out of date.”

The company noted that DB schemes are now typically closed to new entrants and have a more mature profile, with around £50bn paid out annually, stressing that strategies should adapt to reflect the “practical realities” of these requirements.

It also clarified that whilst the suggested approach may not be appropriate for distressed schemes, it would allow those with viable sponsors who intend to run off their schemes over time to focus on generating cashflows for paying pensions as they fall due, rather than transferring to insurers or consolidators.

In particular, it explained that this can include a diversified portfolio of assets whose income matches the pension obligations, acknowledging that many pension schemes already operate like this to some extent, with opportunities to optimise and extend the approach further.

Commenting on the analysis, PWC pensions actuary, Emma Morton, added: “The £190bn deficit represents money that companies are planning to pay into their DB pension schemes over the next decade or so.

"In a lot of cases this money won’t be needed - or, at least, it isn’t needed yet.

“In the current economic environment, trustees and sponsors could be asking themselves whether there are more efficient ways of running pension schemes.

“This would allow spare company cash to be directed elsewhere, such as topping up pension accounts for defined contribution (DC) members who typically have lower pension values than defined benefit members."

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