Why One Expert Fears U.K. Pensions Are Headed for a Cash Crunch

(Bloomberg) -- Part of the U.K.’s more than $7 trillion pension industry is facing a looming liquidity crunch, according to one of its leading consultancies.

Hymans Robertson says a “perfect storm” is brewing as the coronavirus sweeps through the economy, heaping pressure on some retirement plans that have already seen liabilities balloon in a matter of weeks.

The slide in gilt yields since mid-February has pushed liabilities for defined-benefit schemes -- those which promise a fixed sum to retirees -- up by 180 billion pounds ($221 billion) to 580 billion pounds, the firm says. At the same time, funds face a double whammy driven by the pandemic -- companies both freezing contributions and laying off employees, who may then seek to draw some of their retirement cash early.

“The risk is that some pension schemes may be forced to sell assets to raise cash in a depressed market,” said Alistair Russell-Smith, head of corporate DB at Hymans Robertson in an interview. “Pension plans which are most at risk are those poorly funded, with high exposure to illiquid, risky assets. The volatile market doesn’t help. It’s a perfect storm.”

It’s a problem likely being replicated on a global scale. With the virus spreading, worried consumers everywhere are reluctant to shop, travel, or eat out. In many countries, government restrictions have reinforced those changed habits.

The demand shock to companies has been huge, and they are racing to cut costs. As they dismiss employees, demand for social security support is surging: About 950,000 Britons successfully applied for universal credit payments in the second half of March, up from about 100,000 in a normal two-week period.

Meanwhile, firms have already begun speaking to trustees that oversee their pension plans to negotiate waivers on regular contributions.

Read more: Virus-Battered British Firms Seek Delays to Pension Payments

“We have seen a number of cases where companies have flagged that they are going to need to ask pension trustees to defer pension contributions for a period of time,” said Russell-Smith. “Deferring sponsor contribution will make their schemes more cash-flow negative than otherwise would have been.”

Most pension funds including defined-benefit plans use low-risk assets such as government bonds as their benchmark discount rate. Falling yields worsen their funding position, in turn threatening their ability to meet oncoming obligations.

The impact of market volatility on the industry as a whole is nuanced, however. Gilt yields briefly spiked in March, and that kind of move can be bad for pension pools that use a liability-driven investment approach, which adjusts strategy according to expected funding needs. When yields rise more than expected, these types of funds tend to face collateral calls.

“It may not be a problem at this point because yields have come down a bit,” said Russell-Smith. “But because of volatility, if yields were to spike upward again, then we might see pension schemes holding LDI get collateral calls on top of other cash calls.”

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