Article August 24, 2020

Focusing on the DB funding level misses the point – can you see the wood from the trees?

Trustees and Sponsors have seen significant swings in the value of their investment portfolios, but also the shifting value placed on pension scheme liabilities.

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The last several months have been a remarkable period for defined benefit pension schemes. Trustees and Sponsors have seen significant swings in the value of their investment portfolios, but also the shifting value placed on pension scheme liabilities. This prompts advisors to offer a deluge of metrics to help trustees govern where they are today as they seek to navigate a path through the current environment. One such measure is the industry’s obsession with funding level as the principal focal point, i.e. the value of your assets today divided by a value of your liabilities. This measure has provided an anchor for many schemes’ investment strategies, journey plans and de-risking paths. But is it missing the point? Should we be paying closer to attention to the GBP deficit instead?

As trustees and Sponsoring Employers emerge from lockdown, the primary emphasis is getting back on track to a sustainable, healthy position for all stakeholders. In doing so, managing demands on corporate cashflow is imperative. One of the biggest drains for many Sponsors today is funding defined benefit scheme obligations, i.e. the deficit (the gap between assets and liabilities). This comes to the fore whether the trustees are conducting their triennial actuarial valuation or assessing requests for the deferral of deficit contributions.

This calls into question which metrics Trustees should focus on. To demonstrate this challenge, the following chart illustrates the importance of deficit versus funding level, using data from PPF7800 Index (Deficit Schemes only) throughout 2020.

In principle, PPF funding levels have remained fairly stable over 2020 despite significant market volatility. On the surface, this is a positive message, but schemes are not out of the woods yet…

Turning to the second line in the chart, the aggregate GBP deficit is now 85% bigger, £141bn higher than the end of last year! Equity markets may have bounced back sharply after Q1 2020 falls, but falling bond yields this completely offset this. So despite significant swathes of deficit reduction contributions paid in the last few years, this is the gap schemes now face from a PPF perspective. The impact on other scheme-specific measures such as the technical provisions, self-sufficiency or buy out is expected to be even more significant.

So now is the time for trustees to take stock of where they are today. With pension schemes having an increasingly finite time horizon and many Sponsors under unprecedented strain, your GBP deficit is the key metric to address.

How are you planning to get back on track today? And crucially, what return, and risk measure should you really focus on? We will cover these aspects as part of the next chapter in this Bytesize mini-series. At R&M, our goal is to deliver a successful outcome for your members and get you out of the woods into the sunshine!

For more information on how to measure the funding metrics which really matter, please contact us.

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This article constitutes a financial promotion and has been issued and approved by River and Mercantile Solutions, a division of River and Mercantile Investments Limited which is authorised and regulated in the United Kingdom by the Financial Conduct Authority and is a subsidiary of River and Mercantile Group Plc (registered in England and Wales No. 04035248).
Please note that all material within this communication is produced by River and Mercantile Solutions and is directed at, and intended for, the consideration of Professional clients only. This document constitutes a financial promotion within the meaning of the Financial Services and Markets Act 2000 ("FSMA"). Retail clients must not place any reliance upon the contents.
The value of investments and any income generated may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. Past performance is not a guide to future performance. Changes in exchange rates may have an adverse effect on the value, price or income of investments.
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