European defined benefit (DB) pension schemes are in a catch-22 situation, where they are unable to take risks due to persistent deficits but can’t cut deficits without taking risks, research has found.

A joint survey by Amundi and Create-Research of 152 DB schemes, across 17 European pension markets, collectively managing €2.1 trillion of assets, sheds light on how pension plans worldwide are juggling with conflicting priorities at a time when asset values are far removed from reality.

The research found that the Covid-19 pandemic has added to the pressures already caused by long-term low-interest rates. Almost half (48 per cent) of schemes said the pandemic has had a negative impact on the longer-term financial viability of plans, versus only 6 per cent who reported a positive impact. The impact on funding ratios and regular cash flows has been net negative too. Hence, 60 per cent expect to migrate members from DB to defined contribution (DC) plans.

When it comes to end game plans, the report explained that pension schemes are forced to rely on two options. The first is run-off: having very secure finances that can pay pensions until the final member leaves (chosen by 41 per cent). The second option is self-sufficiency (30 per cent): a funding position where the plan is unlikely to call upon the sponsor for additional contributions and can produce the required cash flow to pay beneficiaries.

These two options rely on a plan’s own balance sheet to meet its liabilities without relying on its plan sponsor to continue bearing all the retirement risks. Only 38 per cent of plans have the funding status to do that.

Zero-bound rates have conspired against their two, preferred, insurance-based solutions, widely regarded as the gold standard of the end game, the report stated. These involve passing on all pension obligations to an external insurer partially or fully. Only 25 per cent of respondents are in a position to pursue these options. According to one survey participant, “self-sufficiency is not our first choice, it’s our only choice. Low rates are good for economic revival but they have made pensions unaffordable”.

Commenting, Create-Research professor Amin Rajin, who led the project, said: “The more rates have fallen, the faster pension plans’ liabilities have increased. Rising interest rates will not be enough to reverse this spiral. Pension plans will need far higher returns on their assets or fresh cash injections from their sponsors”.

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