UK DB pension schemes need a “once-a-century” performance

Willis Towers Watson said the average underfunded defined benefit scheme requires equities to return 9% above cash rates per annum to avoid deficits in the 2030s

UK defined benefit (DB) pension schemes are overly-dependent on improbable equity returns, and need a “once-a-century” performance to close funding gaps by 2030, Willis Towers Watson (WTW) has warned.

WTW said that the average underfunded DB scheme requires equities to return 9% above cash rates on an annual basis for the whole of the next decade to avoid significant deficits continuing into the 2030s.

However, UK equities have averaged just 3.1% per annum above cash rates since comparable records started in 1704, and have only matched the required 9% rate in one of 20 rolling decades.

Underfunded DB schemes are effectively counting on a once-a-century equity performance if they’re to wipe out deficits this decade, said Katie Sims, head of multi-asset growth solutions at WTW.

She said, simply putting all your eggs in one basket and hoping for unlikely events will not be enough to solve the funding gap.

The analysis is based on the PPF7800 index funding ratios of underfunded UK DB pension schemes as at 31 July 2020.

However, the research also highlights how other international comparators suggest low odds for full funding by 2030.

After analysing data for US equities since 1946, WTW  found that average 10-year returns still amount to just 6.2% per annum relative to cash, and a 9% rate has only been achieved in a quarter of rolling decades.

Sims said that pension trustees need to reimagine asset allocations, and should consider investing in untraditional projects.

A much greater portion of portfolios need to be invested in practical real-world projects that are actively building the economy of the future, she continued.

Sims said, listed equity certainly has a place in the investment mix, but schemes need to think beyond traditional allocations in order to meet the returns they need.