Pension funding: breaking the cycle

June 2016
How can trustees avoid repeating past mistakes and secure stable pension funding?

With pension funding under strain, trustees need to think differently to reduce risks. Richard Dowell looks at how some pension schemes may be repeating past mistakes.

Albert Einstein once said, "Insanity is doing the same thing over and over again and expecting different results." This seems especially true of the investment strategies applied to pension funding.

When you look at what has happened in the UK defined benefit (DB) pension industry, there is clearly a cycle of investment risk. Deficits have increased by GBP 700 billion over the past eight years, despite sponsors having tens of billions of additional contributions (PPF 7800).

The cycle of investment risk

The amount of investment risk being taken for pension funding has led to some severe performance issues for pension schemes. Since mid-2008 there have been four periods of severe falls in the ‘average’ UK scheme’s funding ratio (ranging from 10% to 25%).

Having such big falls makes it hard to recover, and many haven't. The biggest factor affecting schemes is large exposures to interest rates and inflation. Since the financial crisis, liabilities have noticeably increased as market interest rates have continued to fall. The assets haven't kept pace and deficits have significantly increased.

The significant weighting towards equities is also a big exposure which led to a rocky ride. These allocations still seem to be very significant in most portfolios. This isn't a new issue, but the same views are being expressed in portfolios as they have been for many years.

That being said, the pensions industry is expecting economic growth. There is an expectation for equity markets to continually rise and interest rates to rise faster than the market is currently expecting, meaning inflation will fall faster too.

Let's break the cycle

While the industry has been expecting an upturn for many years, history tells us that this isn't always the case. Breaking the cycle and maintaining stable pension funding requires thinking differently. Rather than only expecting the best, trustees also need to prepare for the worst.

Some questions trustees should be considering:

  • How confident are we that the pension industry will experience economic growth?
  • How should we be preparing investment portfolios against the possibility of entering another recession?
  • Do we understand the impact of unstable funding ratios on members, the sponsor and their contributions?

There is a lot of discussion in the pensions industry about using more investment tools. These can help, but how they are used matters most. This is dependent on the philosophy and process, whether it's yours or the team you work with, applied to pension funding.

Using a fiduciary management approach should give you access to a fulltime team and often a wider range of tools. It’s up to trustees to decide whether or not this is enough.

In the end, it is the underlying approach to pension funding that’s important, not the label given to it. For your sanity, it may be time to do something different.

Find out more about stable pension funding

If you would like more information on reducing investment risk for pension funding, please get in touch with us. Or take a look at our services page to find out how we help investors in pension schemes achieve a stable funding ratio.