When considering the impact of Brexit on pensions 2 weeks on from the vote we need to consider the macro-economic effects. The information disseminated below covers both Defined Benefits and Defined Contributions.
- Markets have reacted negatively and while there has been some recovery for riskier asset classes we are likely to see continued volatility.
- Market volatility will continue during the period of uncertainty between now and two further bumps, the order of which are unclear. The UK Government needs to trigger Article 50 of the Lisbon Treaty, from this point there is (apparently) no return and the UK will be on its way out of the EU. Aligned with this will be the negotiations for how the UK’s relationship with the EU will be structured. The triggering of the exit clause and how the UK/EU’s relationship will continue is uncertain and like to be a long and drawn out affair. There is even a growing expectation that triggering Article 50 may not happen. So, there is much uncertainty about the future and this is not good for ongoing investment.
- This has meant the Bank of England is prepared to restart its quantitative easing which is expected to have implications for inflation rates, and the future implications for interest rates which may need to be cut. Although an increase seems to be perennially on the cards. Predicting this is a fool’s errand.
- Government Bond yields have also reached new lows which will have a severe and negative impact on DB funding deficits as unhedged liabilities will grow.
- The UK’s decision to leave has a potential destabilising effect on the EU as other countries decide on their future relationship with the EU.
- Currency areas have seen some of the largest areas of movement with Sterling performing poorly against the dollar and Euro.
In summary, the market turmoil is likely to continue until the political machinations are completed and this could take a number of years.
For members of pension schemes, sponsors and trustees it very much depends on what type of pension scheme is being discussed.
Defined Benefit schemes
Defined Benefit schemes are likely to notice more volatility in their riskier asset classes over coming years with significant returns hard to come by. However, more significantly their unhedged liabilities will have rocketed in value with the fall in the bond yield which does bring to the table discussions around how those liabilities can be hedged using Liability Driven Investment products.
Trustees that haven’t recently reviewed may wish to consider factors and transfer value basis to ensure they maintain pace with the changing economic picture.
Trustees and sponsors should spend some time considering whether the Brexit decision has a positive or negative effect on the prospects of the employer and the covenant. Any change in the Trustee’s assessment of the covenant should be reflected in the investment and funding strategy. The Brexit decision and related uncertainty and volatility does also highlight the importance of the Pensions Regulator’s recent guidance on Integrated Risk Management and how all those involved with pension schemes should have an understanding of the risks the scheme and employer is exposed to, how these interrelate and their impact on the funding, investments and covenant.
With growing calls on sponsor’s funds for deficit recovery contributions the Government has begun to make noises about reviewing the way liabilities are valued, and encouraging those involved with pension schemes to be mindful of the sustainable growth of the sponsor. This is also in the context of a Government consultation on how member benefits could be amended. These are interesting noises and while no one expects the silver bullet to solve the issues with DB pension funding levels, it is clear the Government is thinking about this and ways of dealing with it. We have no timetable but we await with interest any steps the Government and the Pensions Regulator make in this area.
Defined contribution schemes
- Members will also experience the volatility as mentioned above and should be prepared to weather this storm. It is important to remember that pension investments are a long term investment decision and members should expect to see funds fluctuate over future years.
- Annuity rates have tumbled due to the bond yield collapse and would fall further if interest rates were to be cut which is a concern to anyone looking to secure income from their DC fund.
- Members in drawdown may also see their income fluctuate as their fund grows and falls with these turbulent times and care should be taken with regular reviews of investment and income levels.
- Default funds should be monitored closely to ensure the funds perform as expected and provide good value for the members.
- Uncertainty does highlight the importance of advice and members approaching a time when they may want to start drawing on their pension funds should take advice on their options.
In summary, the Brexit decision is likely to bring many challenges to pensions managers and trustees as investment markets reflect that uncertainty. While no one should be panicking the following actions should be considered:
- Communicate with members to reassure them that the Trustees and employer are monitoring the situation
- Trustees may want to review transfer value and factors
- Sponsors and Trustees of DB schemes will need to begin to discuss how they implement an IRM structure
- Trustees and sponsors should discuss the effect of Brexit on covenant reviews
- Schemes with triennial valuations should begin those discussions asap as they are unlikely to show a positive position
We shall continue to the monitor this situation and related developments as they arise and provide further update on the potential impact on your pension schemes and members.
Broadstone Corporate Benefits Limited
T: +44 (0)20 7893 3456