Defined Benefit  

Half of defined benefit pensions lack cash to payout

Half of defined benefit pensions lack cash to payout

More than half (55 per cent) of the UK’s defined benefit (DB) pension schemes are now cashflow negative, Mercer has warned.

Cashflow negative schemes lack sufficient income from investments and contributions to pay member pensions, so typically need to sell assets to meet their liabilities.

Consequently, they are more vulnerable to market corrections since they may be forced to disinvest during a period of market stress. 

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Mercer's poll of 1,241 institutional investors across 13 countries revealed 85 per cent of the remainder of defined benefit pension pots expect to be cashflow negative by 2027.

According to Phil Edwards, Mercer’s global director of strategic research, being cashflow negative was a natural life stage of a mature defined benefit pension scheme, of course, but recent stock market performance may have lulled some into a false sense of security.

He said Mercer's report highlighted that less than 40 per cent of schemes have a formal de-risking journey mapped out.

Mr Edwards said: "This leaves a large body of schemes with no clear plan in place.

"Trustees of cashflow negative schemes need to be sure that, in the event of a large market correction, liquid assets are available to meet cashflow and collateral needs, without requiring the scheme to crystallise losses.

"We would encourage all schemes – large and small – to use scenario planning and stress-test analysis to understand how a market correction might impact their financial health.”

Mercer’s report showed an increase in exposure to hedge funds (from 33 per cent to 37 per cent of investors covered by the survey) as investors respond to the challenging environment for traditional market exposures (such as equities and bonds).

“There is a growing consensus that portfolios dominated by equities, credit and government bonds will offer a relatively unattractive risk/return trade-off in the future,” said Mr Edwards.

“While hedge funds have faced a challenging post-crisis environment, with falling volatility reducing the potential for generating alpha, institutional investors have, in the main, retained their allocations in recognition of the valuable role they can play in portfolios."

Darren Cooke, director, Red Circle Financial Planning, said: “Pension scheme members should not be worried by the negative cash flow in DB schemes. That is what is going to happen as these pension schemes wind up.

"The trustees have to manage the pension scheme so in theory the money finally runs out when the last member dies.  It is like any pension pot, you hope you outlive the pot.”