UK pension deficit could increase by £219bn in a hard Brexit scenario

December 2018
Brexit
• Such an exit could cause a 14% rise in aggregate UK defined benefit pension liabilities, driven by failing interest rates, weakened sterling and a corresponding rise in inflation
• By contrast, a more favourable Soft Brexit could result in a 9% fall in liabilities, reducing the buy-out deficit by £138bn and easing the funding challenge for scheme trustees and sponsors across the UK

 

Read our guide for trustees that looks at Brexit from both a covenant and an investment perspective

The aggregate buy-out deficit of UK pension funds could rise by as much as £219bn (37%) in the event of a no-deal Brexit scenario, according to proprietary analysis by specialist risk manager Cardano. Whilst the terms of the UK’s departure, including the extent of any transitional arrangements, remain the subject of fierce debate, UK trustees and corporate scheme sponsors must be ready to react to the consequences.

Cardano’s risk model indicates that a hard Brexit could trigger a 14% rise in aggregate UK pension liabilities, driven by the impact of falling Gilt yields, failing interest rates, weakened sterling and a corresponding rise in inflation on schemes’ long-term pension obligations.

A hard Brexit scenario could drive a 6% rise in UK pension scheme assets on the back of currency tailwinds; the potential fall in sterling would be positive for the international constituents of the FTSE 100 and indeed for schemes’ allocation to global equity and debt. Yet this potential improvement would be outweighed by the 14% rise in liabilities, thereby widening the UK’s aggregate funding gap.

Conversely, a soft Brexit scenario could cause the UK’s aggregate buy-out deficit to fall by £138bn, a 24% reduction from current levels, driven principally by an 9% fall in liabilities, easing the funding challenge for scheme trustees and corporate sponsors across the UK. With some of the major uncertainties of the UK’s future relationship with the EU removed, a more favourable Brexit would enable growth to improve and with limited slack in the British economy, could increase the pace of Bank rate hikes, strengthen sterling, push up Gilt yields and soften the performance of the FTSE 100.

Commenting on Cardano’s analysis, Kerrin Rosenberg, UK Chief Executive Officer at Cardano, said:

“Brexit presents a very different challenge to UK pension funds, financial markets and the national economy and this week’s parliamentary vote will be a key milestone in the narrative to date. Since the EU Referendum we have had this political event dominate the markets’ mood and attention – yet the quantum and characteristics of the potential market and economic impacts remain relatively unknown. This is a tail risk with a difference because the date of the UK’s exit is known. The runway into March 29th should allow UK schemes and their advisers to prepare for the worst – even if the eventual outcome ultimately surprises on the upside.

“In our day to day analysis of the risks facing UK pension schemes, we model and map out the potential challenges across a broad spectrum of horizons. As our analysis indicates, the risks to schemes’ funding positions should not be underestimated and we would encourage UK schemes to think critically about the scale and scope of risks that Brexit may present and to act now – before it is too late.

“As we enter into 2019, Brexit will be just one of a range of risk factors that schemes should be proactively addressing in their portfolio positioning. We have reached inflection points across a number of fronts: the potential impact of monetary tightening, the global growth trajectory and rising protectionism should be front of mind for trustee and their advisers going into the New Year.”

Ahead of an uncertain Brexit outcome, the key for pension funds will be to keep the impact of either outcome on investment results limited. Trustees and their advisers should consider:

  1. Adjusting their investment strategy based on the impact of a hard Brexit on the sponsor
  2. Hedging interest rate and inflation risk using an LDI toolkit
  3. Limiting the impact of different Brexit scenarios on the growth portfolio through appropriate diversification, aiming to minimise risk in UK assets