Consequences of Covid, Part Six: Institutional Impacts
For financial professionals only
Consequences of Covid: the impact on generations
The coronavirus outbreak has drawn stark lines between generations. Older people are categorised amongst the most vulnerable, and many are suffering loss, ill-health, and loneliness. But the impact of the virus has been felt strongly across other age groups, too. And the true costs to the economy, society and our future generations will only be known in time.
In this series, we will explore the likely long-term financial impact for people at different stages of life, and where their advice needs will lie in years to come.
2020 has shown which pension schemes are most resilient, and which have been swimming naked
The world was turned upside down in 2020 as Covid-19 impacted on all aspects of life. Institutional pension schemes grappled with market volatility, increasing regulation and disruption from remote working. And in the words of Warren Buffet, only when the tide goes out do you discover who’s been swimming naked – some schemes were well protected during this challenging period, while others saw their position deteriorate.
Pension schemes have seen volatility in their assets, with the sharp equity falls in March and subsequent rally. Liabilities of defined benefit pension schemes are valued according to bond yields, and most schemes saw their liabilities go up as yields have fallen, which worsens the funding position. Schemes with a well-diversified investment strategy and less risk were better protected from these sharp market swings.
The market turmoil highlighted the need for a liquidity buffer to meet benefit payments without having to sell assets, because selling assets after they’ve fallen in value locks in losses and incurs trading costs.
2020 also saw more sustainable investing by pension schemes, partly driven by regulation. And with around £3trn held in pension pots, this makes a big difference in tackling issues like climate change.
Regulation and communication
Like many other organisations, pension schemes had to adapt to remote working while paying out all benefits as they fell due while dealing with member queries in a timely manner. This is no easy task and technology plays a key role. Increasing regulatory demands have driven many pension schemes to outsource aspects of their day-to-day operations to professional providers, and there’s a continuing trend of consolidation into master trusts to make governance more manageable.
Communication was critical during this challenging time, with schemes keeping in touch with their members to reassure them. It’s been important to encourage members to continue saving where possible, and to stay disciplined about their long-term investment strategy. For example, some members may have been scared by the market falls or discouraged from further saving if their pot fell in value. But moving into low-risk investments is likely to be detrimental to long-term returns and leaves members with less money to live on during retirement.
At the start of lockdown many pension schemes paused transfers to avoid putting pressure on members to make critical financial decisions when they were feeling uncertain, as well as avoiding moving money in a tumultuous market. As the situation has become more settled, some transfers have resumed. Given the uncertain macroeconomic backdrop and changing situation, financial advice for members has arguably never been so important.
As bond yields have fallen to historical lows, annuity prices have become more expensive, as illustrated in the following chart. Current pricing is only slightly above the lows during the aftermath of the Brexit vote in July 2016.
Despite the costs, some defined benefit pension schemes transferred their liabilities to an insurer during 2020, in order to improve the security of benefits for members. The position of different pension schemes varies drastically. For schemes with a funding deficit, the ultimate goal to secure all of the benefits is likely to have slipped further away as bond yields have fallen. Sponsor companies are likely to need to hold onto cash at the moment, so if a company is struggling and the pension scheme is in deficit, it may be appropriate to agree alternative security (e.g. a charge over a property or other company assets) to help support member benefits.
Turning of the tide?
Overall, 2020 was a challenging year for pension schemes. Schemes with strong governance, a diversified investment strategy and a solid employer have proved resilient, but for other schemes the pandemic has revealed weaknesses.
The hope is that 2021 will be calmer, so schemes can get back on track and members’ financial health can recover. But we’re likely to be living with the pandemic for months to come, as well as dealing with Brexit. Strong governance and risk management will remain key as schemes navigate the next 12 months.
“The above article is intended to be a topical commentary and should not be construed as financial advice from either the author or Parmenion Capital Partners LLP. If a client wishes to obtain financial advice as to whether an investment is suitable for their needs, they should consult an authorised Financial Adviser. Past performance is not an indicator of future returns.”
Any news and/or views expressed within this document are intended as general information only and should not be viewed as a form of personal recommendation. All investment carries risk and it is important you understand this. If you are in any doubt about whether an investment is suitable for you, please contact your financial adviser.