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Liabilities remain in focus

Public equity and bond markets disappointed over 2018. European equities were hit particularly hard, with the MSCI Europe down over 14% by late November. Broad bond and high yield indices also disappointed.

Partly as a result of volatile asset markets, the aggregate deficit of UK pension funds increased sharply in October, with overall funding falling from 97.7% to 93.6% across the month. In the Netherlands, the coverage ratios of the four largest schemes fell from 104% to 101% in October. Lower coverage ratios are likely to stay in focus in 2019.

For both the Dutch system and the UK’s fragmented DB pensions world, increasing deficits raise questions about how funds will act if there is a continued downturn in asset prices in 2019 . 

The absence of a new Dutch occupational pension framework following the collapse of talks in November is a key factor, and means there is no ‘good news’ story to sell to the membership. This is urgently needed to counter an erosion of trust in the current monolithic system.

Some funds face the prospect of communicating more bad news to members. ABP has seen its chances of escaping recovery diminish.

Pension talks collapsed at the end of November amid recriminations between the three parties – government, employers and unions. 

The main sticking point was the level of compensation for older workers affected by the planned end to risk sharing between generations in the current system, which forbids different rates of accrual for generational cohorts. 

Ending intergenerational risk sharing is seen as crucial to restore trust in the system given the explicit cross subsidy between younger generations better able to bear risk and older generations, who would have to endure a lower level of accrual (or higher contributions) in the proposed new system.

In the UK the likely strategy is more complex interplay of asset markets, liabilities and sponsor strength. According the Bank of England*, nearly 70% of pension assets are held by stronger sponsors (using end-2016 data), although just over 50% of funds were held to be weak, with funding ratios below 80%. 

The authors of the study find that weaker sponsors are more likely to invest more heavily in bond markets in the face of higher liabilities to reduce sponsor risk. Stronger sponsors are more likely to invest countercyclically in the face of falling equity markets, whereas weaker sponsors are more likely to ‘derisk’ and switch into bonds in this scenario.

Given overall pressure on funding rates and falling asset markets, 2019 looks set to be a year where good governance and adaptability to external events will be crucial.

*Bank of England Staff Working Paper No. 57, Douglas & Roberts-Sklar, October 2018

Liam Kennedy, Editor
liam.kennedy@ipe.com

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