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Mercer: Majority of European Pensions Now See Cash Flow Deficits

Investment consultants are working with asset managers to help struggling defined benefit schemes in Europe.

  • Joe McGrath

A majority of European defined benefit pension plans are now paying out more money than they are bringing in for the first time ever, according to consulting firm Mercer. 

Fifty-five percent of DB plans are now “cashflow negative,” up 13 percentage points from last year, Mercer found in its 2017 European asset allocation survey. The survey, released Monday, was conducted among 1,241 institutional investors across 13 countries in Europe and representing assets under management of €1.1 trillion ($1.24 trillion).

The outlook for the pension plans is grim. Nearly 85 percent of DB plans that currently have positive cash flow are expecting to pay out more than they bring in over the next 10 years, Mercer’s report shows. The shortfall has prompted asset management firms to work with investment consultants on ways to help pension schemes meet their payment liabilities, according to Colin Fitzgerald, Invesco Asset Management’s head of EMEA, or Europe, the Middle East and Africa.

“We are beginning to see the various consultants thinking about how they address that,” Fitzgerald said in an interview. “It will become a cash flow matching situation.”

Eighty-eight percent of pensions are meeting their payment demands by selling some of their assets, according to the survey, with only 29 percent changing the investment mandate to accommodate an income element.

As schemes seek to match asset allocation to cash flows, 34 percent of DB plans are planning to increase their exposure to inflation-linked government bonds and 28 percent to domestic fixed-interest government bonds, the Mercer report shows. Twenty percent expect to reduce their allocation to real estate, while 16 percent plan to pare exposure to alternatives and 19 percent said they'd trim domestic equities.

Adam Lane, senior strategic solutions group consultant at Mercer, wrote in the report that the "popularity of cashflow matching is clearly set to grow over time.”

While DB plans traditionally have sought to reduce exposure to growth assets in favor of those with income matching their liabilities, they’re now also seeking investment ideas that offer a little growth, according to Alistair Jones, portfolio solutions group strategist at Schroders.

“If you come into a cash flow matching position with a strong funding level, then you are in a very good position,” he said. “But if you wait, and build up a 20 percent deficit, then we have very different conversations.”

The Mercer report found that six percent of plans have implemented strategies to manage low-volatility equity risk, while 63 percent had not considered such strategies.

DB plans, which guarantee a level of income in retirement, have become unpopular with British companies in recent years as they can be expensive compared to defined contribution plans. DC plans do not guarantee retirement income to workers.

The Pensions Regulator, a group that protects workplace pensions in the U.K., said in a November report that just 15 percent of defined benefit schemes remained open to new members last year. The report showed that active memberships in British DB plans had fallen to 1.65 million people, from 2.42 million in 2010.