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Cashflow management – the next big challenge?

Of course, trustees’ and sponsors’ main aim is for their pension scheme to be fully funded. With yields persisting at historic lows, this may seem some way off for many schemes. However, a number of other factors, such as strong equity returns and a downturn in mortality improvements, could lead to improved funding levels in the near future.

To date, equity values have held up well against major uncertainties surrounding Brexit and other global economic events and, while it is difficult to say if these positive returns will remain, it is important to consider how schemes should react if funding levels do start to improve.

Improved funding levels and lower deficits mean that sponsors’ deficit recovery contributions may fall and this can put a strain on a scheme’s cashflow requirements. This, combined with the fact that more and more schemes are closing to future accrual, means that the total income for many schemes is quickly falling.

Furthermore, members, attracted by what’s on offer in this low yield environment which is having such a negative impact on scheme funding levels, are increasingly opting to take transfer values. With outflows rising and income falling, many schemes are already cashflow negative and many more will follow suit shortly.

Schemes are therefore becoming more reliant than ever on their assets to meet ongoing benefit payments and this presents a number of issues:

• Many schemes are reliant on generating positive returns from their asset holdings and investing in more liquid assets can often lead to lower expected returns.
• Forced asset sales may be required to meet short term cashflow needs and these can be particularly damaging in volatile markets.
• If schemes do switch to more liquid assets, lower expected returns can impact discount rates and lead to increased deficits, providing further challenges for negotiations between trustees and sponsors.

Our view: Whilst scheme funding is and should remain the main focus, it is important for trustees and sponsors to consider their future cashflow requirements before schemes turn cashflow negative.
In our next article we will discuss a number of investments that schemes can consider in such an environment.