The UK defined benefit (DB) pension industry has entered into a new and perhaps final phase: driven by the combination of a dire funding crisis and strict mark-to-market accounting rules for corporate plans, plan sponsors are shifting their attention from traditional corporate portfolio management tasks to broad strategic efforts to minimise – and if possible eliminate – risks associated with the operation of DB plans.
The results of Greenwich Associates’ 2010 UK Investment Management Study reveal the following trends:
- The pace of DB plan closures accelerated dramatically from 2009 to 2010.
- For the first time, meaningful numbers of corporate plan sponsors report they have closed their plans to new accruals or expect to do so in the next two to three years.
- One in 10 UK DB plans have implemented a full or partial buyout and 16% expect to implement some form of buyout by the end of 2010.
- One in 10 DB plan sponsors expect to offer plan participants incentive payments or enhanced transfer values (ETV) to encourage the movement of employees out of DB plans and into defined contribution (DC) structures.
- Almost half of corporate plan sponsors interviewed in 1Q10 said they planned to change their investment policies in the next 12 months to reduce investment risk.
- Plan sponsors’ commitment to de-risking DB portfolios has relegated UK equities to the role of a minor asset class. As recently as 2004 domestic equities made up one-third of DB pension assets in the UK. Today allocations average 18.3% and plan sponsors intend to reduce them further in coming years.
“Although the process remains in its early stages, there is no doubt that the market crisis and resulting funding shortfalls have pushed forward the timetable for the reform of public sector pensions and for the wind-down of corporate DB pension plans,” said Greenwich Associates consultant Marc Haynes. “As the process accelerates, it will affect a growing number of private and public sector employees – including current plan participants.”
Recovery Provides Little Relief
Assets under management among corporate and local authority DB plans in the UK grew by approximately 19% last year. Based on the assets under management (AUM) amounts reported by pension funds interviewed in the first quarter of 2010, DB investment portfolios have returned to, and in some cases, even exceeded pre-crisis levels. Although the strong recovery in global financial markets contributed to this rebound, the market effect alone would not be sufficient to explain the reported growth in pension portfolios. “Some plan sponsors made large cash contributions to their DB plans,” said Greenwich Associates consultant Chris McNickle.
Strong growth in assets under management did not translate into better funding levels for UK pensions. Average funding ratios for DB funds in the UK declined to 80% in 2010 from 83% in 2009. That disappointing drop – which followed the plunge from the recent high of 91% from 2008-2009 – was the result of persistently high valuations of long-term pension liabilities caused by historically low interest rates.
Equity Allocations Resist Stock Market Rebound
The de-risking of corporate DB plans has taken a heavy toll on pension investments in domestic equities. During the Greenwich Associates research period, which spanned from the middle of 1Q09 through to May 2010, the FTSE 100 gained almost 30%. Over the same stretch, corporate DB allocations to domestic equities barely budged – rising only to 15.8% from 15.1%. Allocations to active domestic equities actually fell to 6.2% of total assets in 2010 from 8.6% in 2009 while allocations to passive UK stocks increased to 9.6% of assets from 6.5%.
Free from the most onerous accounting requirements that have been imposed on their corporate counterparts, local authority pension plans have maintained larger allocations to UK stocks. These allocations actually experienced a decline to 24.5% of assets in 2010 from 25.2% – a slight reduction, but one that seems especially notable due to the overall appreciation of equity market values during the period.
Over the next six to 12 months, Greenwich Associates predicts increases in overall DB allocations to active domestic equities, property and passive international equity strategies, and decreases in allocation to passive domestic equities and cash. These predictions are based on a comparison of current allocations to pension funds’ reported target allocations, to which most plan sponsors expect to rebalance by 1Q11.
Looking out over a longer horizon, it’s highly likely that UK pensions will continue to shift assets out of domestic equities and into fixed income. Twenty-two percent of plans say they plan to reduce target allocations to active domestic equities over the next three years and 20% expect to reduce target allocations to passive equities. Only 5% expect to increase allocations to either strategy. Meanwhile, between 15% and 20% of pensions plan to increase target allocations to active and/or passive fixed income, with only 7-9% predicting decreases to either strategy.
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