I defined benefit pension plans are going through an unfavorable phase, despite the equity markets traveling at historic highs. The reason? “A toxic mix of demographic ageing, strict regulation, rising inflation and falling interest rates has severely damaged their financial viability”. One claims it research by Create-Research and Amundi, explaining that these vehicles hang out inside of a vicious circle: on the one hand "they cannot afford to take risks in the presence of persistent deficits in a plan that is approaching its expiry"; on the other, “they cannot reduce deficits without taking risks” and “the dramatic fall in interest rates over the last decade has made things worse”.
The survey - carried out on 152 defined benefit pension plans in 17 European markets - also shows that the situation has worsened with the pandemic. “Nearly half of the subjects (48%) confirm the negative impact on the longer-term financial sustainability of the plans, while only 6% report a positive impact – continues the study – Even the net impact on the financing and regular cash flows was negative. Therefore, 60% plan to migrate members of defined benefit plans to defined contribution plans”.
Unlike what happens in normal supplementary pension funds, in defined-benefit funds, payments by workers are periodically adjusted also taking into account the yield of the fund, so as to constitute an annuity of a predetermined amount. Precisely because of their nature, “more rates have gone down, the faster they are increase liabilities of pension plans – explains Professor Amin Rajan of Create-Research, who led the study – Raising interest rates will not be enough to reverse this spiral. Retirement plans will need to much higher yields on their assets or of new liquidity injections by their sponsors.
So what to do? In most cases, the liabilities of the researched plans mature quickly, so the intervention of an external insurer is excluded. The only option is to find a balance between divergent factors: increasing risk to fill the funding gap, maintaining the capital base and generating adequate cash flows.
According to Pascal Blanqué, group chief investment officer of Amundi, “invest in risky assets it may not be the best option for some pension funds, but sadly it is the only one. This is not how the final phase of solvency risk management until the liabilities of defined benefit pension funds should have been settled”.
