One of the best things about working for First Actuarial is our resolute refusal to see the world any way but our way! As common sense (pragmatism) is what guides us, we are happy to have the courage of our convictions. FABI (or the Fab index for long) is a way of looking at the state of our defined benefit schemes based on common sense.
This is the third month we’ve published the index and I’m pleased to say – nothing much is changing- schemes are still – in aggregate – in surplus. They still need to achieve 3.1% pa growth to stay that way and liabilities remain consistent.
This month we see some dark clouds on the horizon – as the melodramatic title suggests!
First Actuarial Best-estimate Index ( “FAB Index” for short) fell slightly over the month to 30 November 2016. The FAB Index shows that the UK’s 6,000 defined benefit (DB) pension schemes have an overall surplus of £296bn measured on a best-estimate basis.
Increased bond allocation reduces future expected returns
The slight fall in the FAB Index was due to new data on the average asset allocation of the UK’s pension schemes. According to the new edition of the Pension Protection Fund’s (“PPF’s”) Purple Book, the average allocation to bonds has risen to over 50% for the first time as shown in the table below.
The higher allocation towards bonds means that less money is invested in equities (which are expected to give better returns in the long-term). Therefore, although bonds yields increased during November, the lower allocation to equities means that the overall expected investment return on assets actually held has fallen. This accounts for the drop in the monthly FAB Index.
Schemes only need average return of 3.1% a year
Analysis by First Actuarial shows that the overall investment return required for the UK’s 6,000 DB pension schemes to be 100% fully-funded on a best-estimate basis – the so called ‘breakeven’ investment return – has remained at 3.1% pa. This means that UK pension schemes remain in a healthy position for so long as they keep faith in equities.
The assumptions underlying these results are as follows:
Rob Hammond, Partner at First Actuarial said:
“UK pension schemes are being strangled by an overly cautious investment strategy with the average asset allocation to bonds increasing to over 50% for the first time. This overly cautious investment strategy is stifling returns on assets and increasing the amount of reserves that pension schemes need to hold to meet their liabilities. This in turn increases financial demands on employers to meet any shortfalls that arise.
“Our analysis shows that the long-term investment return required to achieve a best-estimate funding position of 100% has remained at 3.1% pa. This ‘breakeven’ investment return is equivalent to only -0.6% pa in real terms, and should therefore be easily achievable.
“The stability of this return shows the advantages of maintaining a balanced investment strategy. However, if UK pension schemes continue to increase holdings in bonds, the healthy financial position of these schemes will be put at risk.”
The FAB Index will be updated on a monthly basis, providing a comparator measure of the financial position of UK DB pension schemes.