Pension funds face tough fight to erode huge deficits
Share markets would have to perform far above the norm to allow pension fund managers to make up their deficits
Britain’s traditional pension funds would need fantastically improbable returns from shares to erode their huge deficits over the next ten years, according to a warning yesterday from one of the pension industry’s leading consultants.
Share markets over the past three centuries have delivered an average of 3.1 percentage points a year in excess of cash returns, yet pension funds would on average need excess returns of 9 percentage points to clear their shortfalls, Willis Towers Watson said.
The warning comes amid concern that the deficits of traditional defined benefit schemes are on the rise again because of ultra-low government bond yields. The aggregate deficits of the 5,400 schemes in Britain worsened from £174.8 billion in June to £199.5 billion in July, according to Pension Protection Fund data.
The Pension Regulator typically expects sponsors of DB schemes to have plans in place to close their deficits within a decade, through a combination of recovery payments and investment returns.
However, Katie Sims, head of multi-asset solutions at Willis, said that UK equity returns had only delivered that target of 9 per cent a year in one in every 20 rolling decades going back to 1704.
Even Wall Street, one of the strongest share markets, has only produced equity returns averaging 6.2 per cent above cash. US shares only achieved the 9 per cent a year target in one in four rolling decades going back to 1946.
“Underfunded DB schemes are effectively counting on a once-a-century equity performance if they are to wipe out deficits this decade,” Ms Sims said. “Simply putting all your eggs in one basket and hoping for unlikely events will not be enough to solve the funding gap.”
She said current expectations may have been coloured by the strong performance of equities over the past ten years when, thanks to quantitative easing, shares in both the UK and the US have achieved that 9 per cent per annum return.
Historically, decades of strong equity performance have been followed by under-average performance in the following decade.
Millions of people are due pensions from traditional DB schemes, sometimes known as final salary or average salary schemes, most of which are closed to new members. However employers continue to be responsible for ensuring that the schemes are funded to pay all pensions as they fall due.
Willis is advising clients to widen their portfolios of risk assets to include unlisted companies and infrastructure as a way of boosting risk-adjusted returns. It calculates that pension funds might be able to boost average returns by 2 percentage points a year.