Put in an international context, UK pension assets represent 120% of UK GDP, well above Germany (8%), France (12%) or Japan (31%), although lower than the US according to OECD data (174%). Funded defined benefit plans hold about £2 trillion in assets, while defined contribution plans account for another £213 billion.
Since the ONS began counting in 2004, private companies have put £520 billion of employer cash contributions into the DB plans they sponsor. While the value of assets has reached £400 billion by 2022, the sharp rise in bond yields has shrunk the present value of their liabilities even more, leaving the schemes in a much better financial position. (When bond yields rise, the present value of the pension liability falls.)
With such large employer contributions and rising bond yields combined, the problem such plans were designed to solve – how to provide pension security for retirees – has now been largely solved. This is good news for current and future retirees who are fortunate enough to receive defined benefit pensions. The same is true for companies fatigued by the seemingly never-ending demand for new capital for pension funds. But from a societal perspective, the disappearance of this problem presents a new challenge.
Companies that sponsor well-funded DB plans can offload their obligations to members in the so-called bulk annuity or “buyout” market. This is the ultimate goal of many sponsors. The insurance company will assume responsibility for paying the retiree’s expenses. The price is usually paid in cash and gilts, and the insurer then invests the assets in a range of bonds, private debt and equity release mortgages. According to LCP – an investment adviser that has advised on 35% of large deals since 2014 – some £340 billion of pension assets have been transferred by the end of 2021, and as more schemes announce the completion of this work, it is expected to hit a record high.
The accelerated exit of major players in the gilt market has far-reaching implications for fixed income market structure, government financing, the transmission of monetary policy and aspirations within government, in New York City and beyond, as our vast pension assets are deployed in a way to fund growth and innovation. But it also creates a new investment landscape in which a small group of insurers will have tremendous market power.
Today, the interests of 10.1 million members of private sector DB plans are overseen by some 5,200 boards of directors, their advisors and their managers. the LDI crisis has clearly demonstrated the lack of heterogeneity in investment strategies for exposures that might be assumed to come from such a large group of investors. But a future in which eight insurers dominate the market does not seem entirely unproblematic.
Many asset management business models rely on a large number of UK DB pension assets to manage, and these models are set to change. But despite the accelerating rate of DB pension churn, most people I spoke to in the industry were relatively relaxed.
One factor that provides comfort is the illiquidity of a well-funded scheme. It is difficult to make acquisitions when a large portion of your assets are frozen in commercial real estate funds or locked up in private equity vehicles. Valuations of illiquid assets are still being done regularly, but there is a strong suspicion that they may have been “marked to believe” after the public asset market crash last year. And illiquid assets can only be sold at a significant discount to their quoted price. Doing so would pose a challenge to the trustees’ role as fiduciaries.
Second, pension administrators have serious supply chain bottlenecks. Double-checking that the correct spouse details are coded in the right system for tens or hundreds of thousands of plan members is slow work, and there simply isn’t enough capacity to complete the paperwork required by insurers. As one consultant put it to me, the ability to migrate to acquisition looks to be only £50 billion a year, which is little more than a rounding error in the context of a £2 trillion pensions market. The constraints are real. But they are not permanent. The financial landscape of the UK is changing.
