Brexit: the impact on UK pensions and financial markets

July 20, 2016

The following article was written by our UK partner firm, Hymans Robertson, and provides insight, from a British perspective, on how the Brexit vote may affect UK Pensions and on the financial markets in general.

Whether you agreed with the decision of the UK electorate or not, it is hard to underestimate how momentous this is. The ramifications are likely to be felt not just in the UK, but in Europe and indeed worldwide.

For now, what is certain is that the UK’s decision to leave the European Union has led to a huge amount of political and economic uncertainty. But risk never comes alone. It is always accompanied by opportunity. It is important that our plans include scenarios in which those opportunities are grasped.

What does the result mean for pensions and the wider risk management markets? Clearly there has been an immediate impact on markets and the funding positions of Defined Benefit (DB) pension schemes; but the full, longer-term impact remains to be seen.

What’s happened to markets?

Following a Brexit vote financial markets responded even more dramatically to the result than expected. Markets moved sharply, with the FTSE 100 slumping 8.7% on opening and the pound hit a 30 year low against the dollar with a record intra-day swing. Equity markets have subsequently rallied and are now ahead of pre-23 June levels, although sterling has stabilized down at c.US$1.3 and c.Euro1.2 to the pound.

As is often the case in times of extreme uncertainty and volatility we expect to see a “flight to safety”. Coupled with a material write down in the GDP forecast for the UK, there has been a material fall in UK Government yields, with 10 year gilts now yielding just 1.0%.

What should those running DB schemes do?

We always caution against knee jerk reactions to short term market volatility. Those running DB schemes need to remember that pensions are a long-term game.

Pension funds have been limited in their ability to protect themselves fully from the uncertain outcome of the EU Referendum. Following the vote to Leave, it’s likely that falls in expectations for UK GDP growth will ultimately weigh on equity markets and on interest rates – putting more pressure on funding deficits.

We’d expect continued volatility over the coming weeks as investors decide what the result means for the outlook for different investments and as the political ramifications of the vote to leave unfold. The threat of another Scottish referendum will add to uncertainty and volatility, and there is the potential for a wider domino effect to hold similar EU Referendum votes in countries across Europe, which would place pressure on the make-up of the Euro.

While we’d advise schemes to avoid over-reacting to short term market volatility, as the dust settles, it may be worth considering whether any changes to investment strategy are required. Particular care should be sought if any triggers have been breached and we recommend seeking clear advice before taking any action.

What is the impact on DC members?

Falls in markets might create concerns for members of DC schemes. For members where retirement is not imminent there is no need for action – they have time for markets to recover – they should maintain contributions and potentially gain from buying into markets cheaply.

Most DC members where retirement is not imminent will typically have a significant allocation to overseas shares where the falls in markets have been offset largely by gains in overseas currencies relative to the pound sterling. DC members closer to retirement tend to be invested in defaults that are more defensively invested and hold a significant amount of cash and UK bonds, where values have held up well so far, and these members should see limited impact from falls in shares and pound sterling.

What does this mean for sponsor covenant?

While the short term economic effects will be predominantly negative, the pain will not be shouldered equally. Companies will be waking up to a new dawn today, and contingency plans will be kicking into place. Trustees will rightly want to understand what these plans look like, and reassess their scheme funding strategies accordingly.

The need for more resilience:

What events of recent weeks do highlight is the need for schemes to become more resilient to risk. Specifically, they need to ensure they don’t take more risk than they need to.

The risks associated with holding too much in volatile risk based assets are more acute for schemes which are more mature. Without a clear disinvestment plan, schemes can find themselves forced to sell assets at inopportune times. This exacerbates underlying market volatility.

What will be the legislative impact?

Much of our pensions and insurance legislation and regulation has been produced by the European project – the recently implemented Solvency II is just one example. While it is hard to see any rollback of antidiscrimination legislation, depending on the future trade contract agreed with the remainder of the EU, the UK has more freedom to set its own policy. What this means is impossible to say at the moment, but we will all need to keep a watching brief in the months ahead.

For more on our partners in the UK, Hymans Robertson.

We can help

If your company has operations in the UK, or elsewhere around the globe, we can help. October Three provides global consulting services that offer a more personalized alternative to ‘big company’ firms. We provide you convenience and peace of mind, unburdened from policies set by a remote head office.

As the sole U.S. member of Abelica Global – a worldwide consortium of elite, independent, actuarial consulting firms – October Three provides clients with direct access to leading experts, research and technology designed to address a myriad of international consulting needs. No one can service the local market like a local independent firm.

Please contact Ray Aguilera for solutions to your global consulting needs.

Share this with your Colleagues:

Latest News:

  • Budget deal retirement savings provisions - Read More
  • January 2018 Pension Finance Update - Read More
  • DB funding and 2017 tax planning - Read More
  • PBGC finalizes regulation revising missing participant program - Read More
  • Current outlook – 2017 year in review - Read More
  • Cash Balance Plan Design - Read More
  • ReDefined Benefit Plan™ - Read More