Shifting considerations for defined benefit pension schemes in 2024 

After a historic year when defined benefit schemes became significantly better funded, 2024 may be the time when the remaining risks come into greater focus

  • Despite the move to simplify and de-risk portfolios, significant credit, collateral and climate transition risks remain. There may  also be opportunities in illiquid markets
  • For those schemes that choose to ‘run on’, there will be choices to make about how to maximise surpluses

It is difficult to think of a scenario where the investment landscape for defined benefit (DB) pension schemes has changed by more than we have witnessed over the course of 2022 and 2023.

The 5% rise in Bank of England policy rates since December 2021, and similar increases in bond yields, have  transformed DB schemes out of all recognition. They have become far better funded, with over 25% in surplus, and are around 40% smaller in size on aggregate. What’s more, the average scheme maturity has plummeted from 17 to 12 years. While rising yields play the greatest part in this dramatic shift, falling longevity and an older population have also contributed. 

2023 turned out to be a historic year for DB schemes, with trustees and companies’ finance directors using the luxury of their surpluses to examine transferring the risk of paying pensions to insurance companies. The year was also significant as the Government’s Mansion House reforms began the process of aiming to unlock about £50bn in capital from the biggest schemes, for investment in UK unlisted assets such as private equity or early-stage companies.

The big shift in fixed income markets has allowed corporate DB schemes to simplify and largely de-risk portfolios, although local government schemes are the exception to this. Having repaired their deficits, many corporate DB schemes are increasing allocations to credit instruments while hedging more of their liability risk. They have reached a point where securing benefit payments or transacting with an insurance company is their primary objective.

Looking at 2024, while the high levels of inflation that gripped economies in 2022 are subsiding for now, structural macro-economic risks remain. Our view is that inflation may stabilise close to central bank targets in the medium term, but themes such as peak globalisation, the energy transition and a realignment in commodity supply chains mean that the chances of future inflation shocks and higher inflation volatility have not gone away.  

So, what are the key issues for DB pension schemes in 2024? After 2023’s rush to ‘buy-in’, we believe 2024 will be a time of reflection on the alternative option of running off DB schemes in the interests of scheme members and company sponsors.  Both the Mansion House reforms and the Autumn Statement have helped to shine light on the alternatives to buy-out. We see 2024, therefore, as a year when there will be more conversations about running schemes on, and the appropriate asset allocations and funding policies for delivering maximum value to all stakeholders.  

Markets and companies have actually been incredibly resilient in the face of higher interest rates and geopolitical disruption.  Perhaps due to the many years of easy money.  However, the higher cost of capital and tighter bank lending will bite at some point. Although many schemes are running lower levels of investment risk, they have greater concentration of risks, namely: credit risk, collateral risk (i.e. liability-driven investment (LDI)) and longevity risk. We expect these risks  to all come into sharper focus over the next 12 months.

Below are four related risks and opportunities that we believe trustees and company finance directors should be aware of:

1. The rising risk of credit defaults and downgrades

With schemes typically investing as much as 40% of their assets in credit, and major economies flirting with recession, the task of avoiding credit defaults and rating downgrades will assume greater significance. While downgrades will be the danger of investment grade credit, defaults will rise among sub-investment grade credit issues. Defaults had already been increasing in 2023, with the number globally reaching 118 by September, nearly double the 2022 total, according to S&P. With financial markets discounting the likelihood of interest rates staying persistently high for some years, there’s a prospect of higher levels of corporate distress. That raises the question of whether scheme trustees are wise to value the simplicity of putting all their credit assets with one manager. Would it not be better to diversify credit assets across a range of credit managers rather than being too reliant on the credit selection skills of any one manager? Diversification may prove invaluable in a higher-for-longer world.
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The chart shows 12 month trailing % default rates for US all stocks and US sub-investment grade credit from 1973 to 2023. Areas shaded in grey indicate recessionary periods.

2. Remaining LDI collateral risks

Despite the lessons from the 2022 UK gilt market crisis and high collateral levels, parts of the gilt market remain dominated by DB pension schemes. Yet there is a wall of new gilt issuance – at £240bn a year for the next four years, according to the Debt Management Office. Who will buy these gilts now that DB scheme have largely de-risked?  What’s more, even after recent declines inflation remains well above the Bank of England’s target of 2%. It is easy to see how gilt yields may remain volatile. Now that many schemes have higher liability hedges, following de-risking, trustees will need to concentrate more on monitoring the inherent risks.  Updating liability hedges with greater frequency will make more sense as the impact on funding levels is greater where levels of liability hedging are higher and remaining open minded to more efficient ways of managing collateral would seem sensible.
The chart shows gilt issuance from Debt Management Office and Bank of England activity in the gilt market (quantitative easing and tightening) over the period from 2009 to 2024 and projections from 2024 to 2028.

3. Opportunities in illiquid markets

DB schemes’ rush to transact with insurers has resulted in forced selling of illiquid assets such as private market funds, exacerbating the existing re-pricing of some of these assets for a higher rate environment. As some DB schemes look to ‘run on’, and access their surpluses, the more forward-looking schemes are considering taking advantage of heavily discounted sales of illiquid assets in the secondary markets. If they have sufficiently long-term horizons, they are well placed to take advantage of higher rates and the higher cost of capital.

4. Mitigating climate transition risk

Many DB schemes have already assigned their climate objectives, yet while data to aid decision-making is getting better it is still not where it needs to be.  Aligning credit portfolios to climate goals can be challenging, and further work will be needed to understand how credit portfolios can deliver net zero goals. Asset managers have been struggling to cope with their clients varying demands about how to manage the transition to net zero. However, some are developing better approaches than others. Mercer rates asset managers on their integration of environmental, social and corporate governance risks and opportunities into their investment processes, with four ratings categories. DB schemes may choose to allocate to higher rated managers with approaches that suit their views on the climate transition. What’s more, there are good arguments for diversifying across asset managers with different approaches because the climate transition will bring considerable risks.
The chart shows the total portfolio Net Zero decarbonisation progress relative to the baseline (1.5o Net Zero 2050 base) from 2019 to 2050.


If 2023 was the year that many DB scheme trustees and company finance directors breathed a sigh of relief as their schemes moved into surplus, 2024 will be the year when the practicalities of the new environment come into focus. Those schemes that decide to transfer risks to insurance companies may find that they have to wait for a considerable time as the insurers have limited capacity. This capacity extends not just to their capacity for assuming financial risks but also to the capacity of their employees to process the sheer volume of administration.  Schemes targeting a buy-in or buy-out need to ask how long will it take and how should they prepare?

For those DB schemes that choose to run on, the practical issues are different. They will need to decide on the most appropriate investment strategies in light of their new objectives. After all, incrementally building up surplus will allow them flexibility to increase payments to scheme members, improve security of member benefits and / or return economic value to the sponsoring company.

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