November 7, 2017
In our launch edition, we looked at how big increases in minimum contribution rates for DC pensions…
Defined benefit (DB) pensions loom large over the UK wealth landscape, with huge assets and even bigger liabilities. Shortfalls (actual or potential) between assets and liabilities, and the choices of funds in managing them, make DB particularly challenging in terms of asset management, while DB transfers have become an important part of wealth industry flows.
Asset management perspective
DB assets are substantial: the Pension Protection Fund’s (PPF) universe of DB schemes totalled £1.6 trn in December 2017. This accounted for ~75% of workplace pensions assets and ~35% of the overall long-term savings market.
As an asset management opportunity, DB still dominates the UK, but with the desire to manage shortfalls, the nature of the opportunity has changed considerably. The decision of whether to maximise long term returns via a multi-asset portfolio and wear the risk of a shortfall, or to match assets and liabilities and hedge / transfer out risk, impacts employers, members, and roles available to asset managers and other market participants.
At first glance, AUM growth of +9% pa since 2013 (Figure 1) appears to indicate a product category with healthy growth. However, the situation is more complex.
Figure 1: Defined Benefit Pensions, Assets Under Management (£bn, 2013-2017)
Assets have grown steadily, but so have liabilities, from £1.7 trn in 2013 to £2.4 trn in 2017 (also +9% pa). Despite all the efforts to rein in deficits, over the past five years the aggregate funding level for DB schemes has remained flat at ~66% (on a Full Buyout basis), as showing in Figure 2.
Figure 2: Defined Benefit Funding Level, (% of Liabilities – Full Buyout Basis, 2013-2017)
Liability growth has been driven by two trends:
How have DB assets managed to grow in-line with liabilities? There are three main drivers:
Figure 3: Defined Benefit Stock and Flow Waterfall (£bn, 2013-2017)
Role of DB transfers
Pension contributions are now shifting to DC funds with the closure of DB funds and auto-enrolment to workplace pensions. DB outflows are also significant via transfers, either bulk annuities or individual pension transfers. Post pension freedoms, transfers of DB assets have become increasingly important to the business model of pension and drawdown providers. In 2017 alone, over £30 bn of DB assets were transferred into bulk annuities, DC pensions or drawdown (figure 4).
Figure 4: DB Transfers by Product (£bn, 2017)
How long can this “river of gold” continue to flow? While transfers out of DB in recent years have been boosted by pent up demand and low interest rates (which increase transfer values), in the absence of regulatory obstacles DB transfers are likely to continue in volume:
While DB transfer activity is linked to adviser incentives, it also taps into fundamental consumer behaviours and desires to have control over their retirement finances. The FCA’s latest note on pension transfer advice reflects this, focusing on advice qualifications and charging structures, rather than the appropriateness of pension transfer advice itself.
We expect significant volumes of DB transfers to continue given these alignments. This will not drain the DB system anytime soon. Transfers out of DB in 2017 represented just 2% of AUM; asset returns will continue to have a much bigger impact on the size of the DB system for near future. Meanwhile, a portion of DB assets will remain in a set of “steady state” solutions, across cashflow driven investing (CDI), liability driven investing (LDI) and return seeking assets. We will explore these solutions in the next Citylogue.