The industry welcomed the government’s announcement this week that it would not ban members transferring from defined benefit (DB) to defined contribution (DC) schemes in order to take advantage of the freedoms announced in March’s Budget by the Chancellor George Osborne.
In its own response to the Freedom and Choice in Pensions consultation, HM Treasury said such transfers would still be allowed despite its previous concerns about the impact a potential mass member migration from DB to DC might have on investment and financial markets.
Freedom to transfer should be welcomed as for many savers having access to their pot at retirement is important, particularly those with health issues, high debts or those who want to have more control over how and when they receive their income in retirement – and what happens to it when they die.
At this stage it is difficult to say how many members will transfer across. There is no longer a short-term window to make members to rush to get a transfer done, but what is certain is the fallout from the Budget will result in a net increase in transfers to DC from across the DB scheme population – however large or small.
So with the option available for DB members to switch, trustees still need to be alert to the impact from a portfolio management perspective and there are still some unanswered questions around liquidity. What if there is an significant cash outflow from schemes, resulting in a shorter duration of liabilities, smaller overall scheme size and reduced time frame over which to reach full funding?
According to KPMG’s latest LDI survey some 35% of the UK’s £1.5trn liabilities have already been hedged, however trustees of smaller and medium-sized schemes especially should be particularly concerned about the impact of liquidity. This is particularly the case, as one asset manager pointed out this week, where a small number of individuals could represent 10-20% of the total liabilities. High levels of transfers could force schemes to bring forward their de-risking plans and it is therefore important schemes’ existing growth assets are able to provide this sufficient liquidity.
Also, if the transfers to DC are dominated by older scheme members – highly likely – then the investment ramifications are significant as the usual philosophy of holding gilts will no longer hold true. Schemes could therefore be caught between seeking liability-matching assets outside of gilts and needing to invest in growth seeking assets with sufficient liquidity.
Trustees might therefore have to re-think their allocation to illiquidity at a time when they have been forced to take on more through assets classes such as alternative credit because traditional fixed income has under-delivered.
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