How pandemic impacted the pensions industry

When pen­sions make news­pa­per head­lines it is almost always for neg­a­tive rea­sons. The mas­sive stock mar­ket loss­es of the COVID crash, which saw the FTSE100 lose around a third of its val­ue over the first three months of 2020, have been no dif­fer­ent. So how has this lat­est shock to the sys­tem influ­enced atti­tudes to pen­sions and how have mar­ket play­ers adapt­ed in meet­ing that most impor­tant of all pen­sion indus­try chal­lenges of main­tain­ing pub­lic trust?

Pen­sion providers are adopt­ing increas­ing­ly sophis­ti­cat­ed risk man­age­ment strate­gies to pro­tect savers from the worst of stock mar­ket falls and pre­serve that hard-earned pub­lic con­fi­dence.

The coro­n­avirus pan­dem­ic is the lat­est in a series of black swan events, unfore­seen cat­a­clysmic events that cre­ate stock mar­ket tur­moil and have huge reper­cus­sions for the val­ue of assets with­in pen­sion schemes.

Richard Butch­er, chair of the Pen­sions and Life­time Sav­ings Asso­ci­a­tion, says: “I sense there are prob­a­bly more big risk fac­tors now, the increas­ing­ly vio­lent reac­tions of the weath­er and cli­mate change, feed­ing into the migra­tion cri­sis and broad­er envi­ron­men­tal issues.

“His­tor­i­cal­ly no one has been good at mod­el­ling risk suc­cess­ful­ly, but pen­sion pro­fes­sion­als are now pric­ing in risks we can’t antic­i­pate. We can’t put names on these risks because we don’t know what they are. But we can mod­el the impact of extreme sce­nar­ios on invest­ment port­fo­lios.”

How market participants performed

Diver­si­fi­ca­tion, also known as not putting all your eggs into one bas­ket, has been around as a con­cept for years. Defined con­tri­bu­tion (DC) pen­sion schemes are address­ing pen­sion indus­try chal­lenges of con­cen­tra­tion of assets by ramp­ing up the breadth of what they invest in, going beyond equi­ties, bonds and prop­er­ty, and bring­ing in pri­vate equi­ty and infra­struc­ture.

Diver­si­fi­ca­tion pro­tect­ed DC investors dur­ing the COVID crash. While the FTSE100 fell 34 per cent between Jan­u­ary 1 and the mar­ket low of March 24, work­place pen­sion schemes suf­fered much low­er drops. Analy­sis of sev­en of the UK’s biggest mas­ter trust pen­sion schemes by indus­try pub­li­ca­tion Cor­po­rate Advis­er shows younger savers, those with 30 years to retire­ment, expe­ri­enced drops of 20 per cent over the peri­od.

The process of lifestyling, where old­er savers are moved into less risky assets to pro­tect them against mar­ket shocks as they approach retire­ment age, deliv­ered even more down­side pro­tec­tion. The aver­age old­er saver’s pot fell just 4.2 per cent over that peri­od. Diver­si­fi­ca­tion and lifestyling have been key to address­ing these pen­sion indus­try chal­lenges.

Robert Cochran, senior cor­po­rate pen­sion spe­cial­ist at Scot­tish Wid­ows, says investors gen­er­al­ly respond­ed calm­ly to the stock mar­ket tur­moil and trust in the sys­tem has large­ly been main­tained. “When the stock mar­ket tum­bled, we saw a big spike in cus­tomers look­ing to switch out of their funds to more secure options,” he says.

“Had they done so they would have locked in their loss­es and missed out on the rebound. Because pen­sion providers are get­ting bet­ter at com­mu­ni­cat­ing dig­i­tal­ly with cus­tomers, we were able to suc­cess­ful­ly explain why volatil­i­ty is not nec­es­sar­i­ly a bad thing for long-term savers and the major­i­ty stayed invest­ed.”

Confidence key to weathering pension industry challenges?

That deci­sion to stay put has turned out to be the right one. The rebound in mar­kets has seen the great major­i­ty of DC pen­sion funds recov­er all their COVID-crash loss­es, with the aver­age work­place scheme deliv­er­ing a pos­i­tive return for younger savers of 0.9 per cent in the year to June 30. Old­er savers, with­in a year of state pen­sion age, reg­is­tered a pos­i­tive return of 2.8 per cent.

Mark Futch­er, a part­ner at pen­sions con­sul­tan­cy Bar­nett Wadding­ham, says: “The big mes­sage dur­ing the stock mar­ket tur­moil was to pro­vide reas­sur­ance that the strate­gies in place were designed to cater for pre­cise­ly this sort of volatil­i­ty. The indus­try beefed up its mes­sag­ing around this and was large­ly suc­cess­ful; scheme mem­bers and employ­ers were broad­ly reas­sured.

“At the same time schemes also made it easy for mem­bers to tem­porar­i­ly stop their con­tri­bu­tions if nec­es­sary, recog­nis­ing that some house­holds might be strug­gling finan­cial­ly.”

The big mes­sage was to pro­vide reas­sur­ance that the strate­gies in place were designed to cater for this sort of volatil­i­ty

Andrew Chesel­dine, chair of the board of trustees of the Smart Pen­sion Mas­ter Trust, adds: “Mar­kets fell sig­nif­i­cant­ly and they bounced back pret­ty quick­ly. Lifestyling did its job for old­er savers. And even if there hadn’t been an imme­di­ate rebound, for those with 20 or 30 years until retire­ment, it doesn’t mat­ter if the mar­ket drops. Falling mar­kets are actu­al­ly an oppor­tu­ni­ty for long-term savers to buy assets cheap­ly.”

Pressure on DB schemes

Pen­sion indus­try chal­lenges in the area of defined ben­e­fit (DB) schemes are dif­fer­ent. Some schemes have become more pre­car­i­ous as the assets held with­in them have fall­en in val­ue. Legal & Gen­er­al Invest­ment Management’s DB Health Track­er index, which reflects schemes’ asset to lia­bil­i­ty ratio, the demo­graph­ic risks in the scheme and the like­li­hood of the spon­sor­ing com­pa­ny becom­ing insol­vent, showed the aver­age DB scheme could expect to pay 91.4 per cent of mem­bers’ ben­e­fits at March 31, down from 96.5 per cent at the end of 2019. But by June 30, some ground had been clawed back, with the index ris­ing to 93.5 per cent.

Chesel­dine says: “There are many well-fund­ed schemes out there with the resources to weath­er the storm. But in strug­gling sec­tors, such as avi­a­tion, retail and hos­pi­tal­i­ty, there may be schemes whose spon­sor­ing employ­er goes under and it seems inevitable these will end up in the Pen­sion Pro­tec­tion Fund.”

How­ev­er, no high-pro­file schemes have fall­en over yet and trust in DB schemes has not been erod­ed so far, say experts.

Cli­mate change is seen by the gov­ern­ment as one of the great­est of pen­sion indus­try chal­lenges. New reg­u­la­tions force both DB and DC schemes to chal­lenge long-term invest­ment risk, by mak­ing them evi­dence the sci­ence behind their invest­ment deci­sion-mak­ing, par­tic­u­lar­ly in rela­tion to envi­ron­men­tal, social and gov­er­nance fac­tors, with a spe­cif­ic focus on cli­mate change.

Indus­try experts say it is too ear­ly to say whether this lat­est in a series of seem­ing­ly increas­ing­ly fre­quent “once-in-a-life­time” events will change atti­tudes to retire­ment. But they do report a longer-term trend towards pen­sions becom­ing just a part of a big­ger, broad­er retire­ment plan.

Chesel­dine con­cludes: “This trend will con­tin­ue to be dri­ven by the tighter restric­tions on the amount you can pay into your pen­sion. Inter­est in ISAs (indi­vid­ual sav­ings accounts), par­tic­u­lar­ly the Life­time ISA, is grow­ing, both among employ­ers and mem­bers of the pub­lic. And for many peo­ple, res­i­den­tial prop­er­ty, whether their own home or buy to let is increas­ing­ly seen as part of their retire­ment plans.”

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