Business Regulation » Finance directors advised to tackle increasing defined benefit pension risks

Finance directors advised to tackle increasing defined benefit pension risks

abrdn’s Brian Denyer believes it must be a priority in the wake of gilt market volatility and increasing regulations

There is a need for finance directors to tackle the problems caused by legacy defined benefit pension schemes in light of economic volatility and increasing regulatory pressures.

“They need to review the risks involved,” says Brian Denyer, senior solutions director at abrdn. “Once they have all the information, they can then make informed decisions that are consistent with their risk appetite.”

Denyer believes the combination of gilt market volatility, maturing schemes and increasing regulations has made this issue a top priority.

“There’s been massive volatility in the gilt market,” he says. “This has a material impact on defined benefit schemes as their schemes’ liabilities are measured with reference to gilts, and they also hold lots of gilts within their investment portfolio.”

“That’s why it is important to understand how gilt volatility may affect future funding requirements,” he adds.

Regulatory pressures

These volatility issues come at a time when financial directors are also facing the prospect of increasing regulatory pressures having a longer-term impact on their obligations.

“We have got a new funding code that is expected to be implemented later this year,” says Denyer. “For some pension schemes that could result in an increase in funding requirements.”

Then there is the new single code of practice coming from the UK’s Pensions Regulator. “That is going to increase the cost of compliance by requiring more robust governance models,” he adds.

The harsh reality is this combination of policy changes could potentially trigger an increase in both funding costs and the overall expenses of running schemes.

“This might put a greater demand on the resources of small to medium sized pension schemes,” points out Denyer. “It is something that finance directors need to consider.”

Maturing schemes

Another part of the puzzle is the fact so many of these schemes are fast approaching maturity. This means the funding issue can no longer be dismissed as a problem to solve tomorrow.

“Every closed pension scheme in the country is ageing in terms of its membership and companies are very keen to get these legacy finance obligations off their balance sheets quickly,” explains Denyer.

This march towards maturity presents a particularly pressing issue: there is far less time to plug any funding gaps or fix anything that goes wrong with the scheme.

Of course, the natural end goal is for companies to pass off their pension schemes to insurance providers but even that’s not straightforward in the current climate, according to Denyer.

“We have got an excess of demand over supply in the insurance market at the moment,” he says. “Even if companies have the money to pass it off to an insurer, they may not find a provider that’s willing to take it on.”

For businesses, especially smaller operations without the deep resources required to solve these problems on their own, this presents quite a conundrum.

“We have got companies with limited resources looking to allocate them efficiently and an insurance market that’s going to be unable to meet the demand,” explains Denyer.

A level playing field

There is also another issue caused by existing defined benefit schemes, and this relates to how they alter the playing field between companies in the same industries.

“We have got quite old companies with such schemes on the balance sheets competing with newer businesses that don’t have the same problem,” he says. “This puts them at a disadvantage.”

The list of negative factors affecting defined benefit schemes is unlikely to change anytime soon, especially with the looming prospect of a recession and associated financial fallout.

While getting defined benefit schemes off the balance sheet completely is probably the ideal scenario in many cases, for many businesses this is unaffordable so Denyer also highlights the consolidation route.

“Consolidating pension schemes definitely has a part to play in terms of taking the hassle factor away from finance directors and managing everything in the most efficient way,” he says.

The master trust solution

 The way abrdn can help provide a solution is via its pensions master trust, a multi-employer defined benefit scheme that is primarily aimed at small to medium sized businesses.

“It is not going to soak up lots of billion-pound schemes as they generally have the resources to put in place strong governance models and to invest efficiently,” explains Denyer. “Our master trust is aimed at smaller business with pension schemes.”

The primary benefits of the product are robust governance, outsourced investment management, reduced running expenses, and the prospect of an efficient path to buyout.

“We believe our master trust is the first to be launched jointly by an asset manager and an employee benefit consultancy,” says Denyer.

The scheme will be managed by professional trustees and other professionals, as well as having access to a diversified range of assets across private and public markets.

The reduced running expenses – a particularly important point given the upcoming regulatory changes – comes through the economies of scale.

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