The report, co-published by Fathom Consulting and buyout specialists Pension Insurance Corporation, said based on the OBR’s latest forecasts, defined-benefit (DB) scheme finances will improve significantly, with more than half reaching a buyout level of funding within the next decade.
Rising yields and a projected turnaround in the public finances mean that the market value of all gilts is likely to peak, just as the demand for inflation protection starts to build. The proportion of gilts that are index-linked would need to rise from 25% to 75% in order to meet the needs of DB schemes over the same time period, the report claimed.
Fathom Consulting director, Danny Gabay, said the findings of the report: “Who carries the risk? Asset allocation challenges for defined-benefit pension schemes”, begged the question of who should carry the risk of higher than expected inflation?
He added: “If the somewhat rosy economic scenario set out in the OBR’s latest long-term projections were to materialise, it would create a new headache for DB schemes in the form of a serious undersupply of index-linked gilts.
“This shortage is likely to exceed £500bn, leaving a simple, but very real question: who is going to carry the risk of inflation being higher than currently expected? Should UK plc be forced to put even more into DB schemes, putting further downward pressure on investment, risking more corporate failures, and perhaps leaving scheme members exposed? Or should the government pick up this burden?”
Mark Gull, Head of Fixed Income at Pension Insurance Corporation, said: “This huge shortfall leaves schemes with the choice of remaining exposed to unexpected changes in inflation, or purchasing expensive inflation hedges. However this issue is addressed there will be major financial implications for UK companies, who will most likely have to make good any shortfall. This may also put additional strain on the Pension Protection Fund.”
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