Scary headlines make us all concerned about our own financial security. How the global financial downturn will effect those proving pensions products through the workplace is in great part down to the way their businesses are structured.
Depending on the areas where they carry out their business and the way they derive their revenue from the work they do, some advisory businesses will be more insured against this long-predicted economic downturn than others.
Even though equity markets are, at the time of going to press, more than 15 per cent down on their peak at the turn of the year, hovering in the mid-5,000s, they are nowhere near the 3,287 of March 2003.
But with commentators of the calibre of Alan Greenspan describing the state of the US economy as its worst since the second world war, it can be hard to gauge how serious a downturn we are in on this side of the Atlantic. Add to that the collapse of established names like Bear Stearns and Carlyle Capital Corp, which has had both Bush presidents on its payroll, as well as John Major, and our own Northern Rock debacle, and it is easy to see why the bears’ voices are being heard loudest.
Last time markets were in freefall, at the beginning of the decade, they produced an accelerated closure of final salary pension schemes. So with only a fraction of defined benefit plan still open, what could a prolonged bear market mean this time around?
Deborah Cooper, principal at Mercer, says so far final salary schemes are little worse off, in balance sheet terms at least. “It is a mixed story so far, because although equity markets have fallen, credit has got cheaper,” she says. “We estimate on an IS19 or FRS17 measure, there has been little change. This is because changes in corporate bond spreads mean liabilities have reduced by roughly the same amount as the equities that are covering them.”
But Cooper does accept that if the economic malaise continues, we could see pressure on those weak final salary schemes that are already paying higher levies to the Pension Protection Fund.
“Because it has become more expensive for corporates to borrow there could be more insolvency rates in the next couple of years, which could force the PPF to put up its levy. This would, particularly for smaller firms, create increased pressure to revisit those final salary schemes,” says Cooper.
John Lawson, senior technical manager at Standard Life is predicting something of a smaller scale re-run of the 2001/02 experience if the current volatility in the markets turns into a full recession. “With about £50bn knocked off the £500bn in final salary pensions in the last three months, we are going to see greater pressure on DB schemes.” he says. “I predict of the 3m active members in final salary schemes, there will be just 1.5m left in a few years, as the combined effect of closures and staff turnover takes its toll.”
One man’s poison is another man’s meat, and many of those operating in the DC environment could actually profit from the market turmoil, if it results in a further increase in employers seeking refuge in pensions schemes with closed-ended liabilities.
But new scheme acquisition aside, the effect of poor equity markets on existing business depends very much on the way a corporate intermediary is structured. For businesses operating on trail, the recent downturn will have reduced their funds under management, and a prolonged and deepening bear market will start to eat into revenues quite substantially. For those firms operating on a new member model the state of the markets will mean nothing.
“I think the recent volatility will have an impact on defined benefit schemes which will create greater pressure on schemes, but defined contribution arrangements will be relatively unaffected,” says Tom McPhail, head of pension policy at Hargreaves Lansdown. “That will change if we start seeing job losses, but otherwise the DC industry can carry on regardless.
“But I see the current market turmoil as a business opportunity as much as a threat. We can as an industry push out a range of strong messages at a time like this, particularly as scheme members are in the market for a very long time,” says McPhail.
One area where employers may face problems is those approaching retirement now. Depending on the level to which their plans have derisked their portfolios ahead of retirement, they may be facing annuitisation with sums lower than they had expected. However, in a mirror of the equity/bond relationship that has seen a largely neutral effect on DB funds, annuity levels today are at their highest for four years, so negative effects will be mitigated.
The corporate pensions sector looks like it is in as strong a position as any to weather the current storm. Advisers, employers and employees should comfort themselves with the thought that they are likely to see less of an impact than many other parts of the financial services industry.