The 2021 outlook for DB pension schemes – A post-COVID deep recession or post-war-esque euphoria driven boom?

Thoughts from December 2020: Schemes must be honest about their current position as they scenario plan for 2021.

Across UK businesses, people have been firefighting this year and as we close out 2020 and turn the page to the New Year, companies will be wondering whether we are now through the worst of it, or whether a third wave lies ahead. And, er that little thing called Brexit. Are corporate sponsors of pension funds, and schemes themselves, now able to fully take stock of any damage and the level of stress – or distress – threatening the trajectory of their journey plans?

Over the past ten months or so, many sponsors and schemes will have been taking things one day at a time or one month a time. Yet, despite the challenges we have all felt so far, the impact of COVID-19 has not yet fully filtered down across the real economy (outside of the obvious front-line sectors like hospitality.) While the day to day experience of the crunch through March and April this year, not to mention prolonged lockdowns and restrictions since, has brought continued waves of turbulence for sponsors and schemes alike, there are plenty of schemes that remain relatively well-funded and well-hedged with a sponsor on defence mode for 2021. In our minds, a key marker will be where we are by Easter, as extended government supports are reeled in and the vaccine is rolled out. And, Brexit again – surely we will know where things stand by Easter?!

Shifting regulatory environment

Of course, the outlook for the pensions industry must be viewed against the backdrop of a shifting regulatory environment. The new Pension Schemes Bill, the evolving regime for consolidators and the new defined benefit funding code provide a new and untested regime to respond to the economic, structural and distress tests of the coming months.

If the central scenario is for a major recession, we may inevitably see a number of schemes enter the Pension Protection Fund (PPF).  Year to date, the pensions lifeboat has been perhaps quieter than might have been anticipated (although Acardia and Debenhams are beginning to change that), in part a result of the unprecedented levels of fiscal supports from the government to mitigate the depth of the economic damage to UK businesses and households. But has this merely been the calm before the inevitable storm?

In the scenario that the PPF becomes busy, and the Pensions Regulator comes under pressure from sponsors, it is important to remember the context of the sustainable growth objective brought in following the Global Financial Crisis (GFC). Through this prism, the then government appeared to lean on the Regulator (through revising its objectives) to take the sponsor’s sustainable growth into account, both in its enforcement actions and policy settings.

Under the new Pension Schemes Bill and the new funding code, there is still plenty of scope to toughen or soften the enforcements appropriately as we go into the post-COVID (hopefully) and post-Brexit (hopefully) period.

Of course, this central scenario may not come to fruition. The floodgates have been opened on stimulus from global central banks and governments to the extent that we may possibly have a post pandemic boom: US equity markets in the US are riding high, while uncertainty in the UK continues to ride high due to Brexit – a ball that will bounce one way or the other by the end of the year.

But across the world, the relief at the vaccine rollout may just precipitate the roaring 20s perhaps similar to the last truly global pandemic a century ago; we may surprise ourselves to the upside with consumer spending euphoria in the release from extended lockdown, supported by government spending on infrastructure and the low-carbon economic transition.

In that scenario, I expect the regulatory backdrop will be very much enforced, harnessing that tide of recovery and growth to shore up schemes and funnel into insurers or consolidators while the PPF might continue to be relatively quiet.

It is a plausible scenario, if from where we are today, seemingly an unlikely one. How active and flexed new enforcement powers will be very much contingent on the actual scenario that we find ourselves in.

Looking ahead

At the start of the New Year, schemes should sit up and take stock of their position, which we would categorise broadly into three risk buckets.

In the first category, are schemes that remain fundamentally sound but have been knocked off course. The endgame will take longer to reach than had been planned for, but the assets and covenant have largely absorbed the COVID-19 crisis and the sponsor will continue operating as a viable entity supporting the scheme liabilities.

Second, there will be schemes which have been pushed materially off course and the journey they were on – to insurance or full funding – now looks very distant, if not increasingly unlikely. These schemes will have to re-evaluate what they are aiming for, which may drive the nascent consolidator market.

Finally, there will be schemes that have been hauled below the waterline and, through the course of the pandemic, have slipped down the risk categories to a place where they are likely no longer viable. In these scenarios, we may see more restructuring activity, enabling financially troubled sponsors to detach from scheme liabilities and enter either the PPF or an alternative endgame. The tension between continuing as a viable employer to the current workforce, and meeting past pension promises, will inevitably come under strain, but today, we can be thankful for the much broader range of tools and levers available to safeguard members’ benefits.

Whichever scenario we find ourselves in – either broad recessionary or post-pandemic boom – we will be in a new and untested regime. Fortunately, there are a lot of bright people coming together to face these challenges together, many of whom have already faced and come through the GFC. We were all a bit more junior the last time round, but this is the moment to step up and collaborate in supporting schemes and members to navigate the new world.

Darren Redmayne, CEO

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