UK votes Leave: how pension schemes can cope with uncertainty

The pollsters were wrong again, and the UK public has voted to leave the European Union (EU).

While the longer-term impact on pension schemes has yet to be seen, the decision has hit markets hard and the immediate impact was sharp falls in the equity markets, sterling and gilt yields.

Volatile markets

We expect uncertainty and volatility will dominate the coming months and years and, whilst the worst of this will likely be over the coming weeks, we expect it will continue on some level until markets have a good idea of the terms that will underlie the UK’s exit and how this will impact the UK and European economies. This is likely to take many years and in the meantime markets will be sensitive to political and economic developments, resulting in a bumpy few years for UK pension schemes.

Importantly, given the levels of uncertainty, we would urge companies and trustees not to make knee-jerk decisions. Whilst over the very short-term we might continue to see UK equities and yields fall as investors move to safer assets, the long-term impact of leaving the EU on UK’s economy and markets, as well as global markets, is still very much an unknown.

Understand the risks

Schemes with a funding valuation date shortly after the referendum result will be affected by market volatility.  The Pensions Regulator says that trustees should not be overly focused on short-term market movements, but should understand how volatility impacts on their views of future investment returns and risks.

Trustees are also able to make an allowance for post-valuation experience when setting their recovery plans, particularly when markets have been volatile.

Companies will also have a role to play in helping trustees understand the impact of 'Brexit' on the business.  The covenant could be weakened or strengthened, depending on the effect on the economy, the employer’s particular industry and other factors – such as plans to move business out of the UK.  Trustees will need to consider how this affects the security of members’ benefits and the funding plan in place.

"We expect uncertainty and volatility will dominate the coming months and years."

Balance sheet impact

We expect auditors to pay more attention to pension balances for both year-end and interim financial statements.  The impact on company balance sheets will depend on the scheme’s investment strategy.  Finance directors may wish to obtain an update on the funding position to keep abreast of the situation.

Given the significant market movements it may also be an opportunity to investigate whether assumptions can be reviewed to mitigate any increase in deficit.  Even without the effect of the referendum result, there has been a significant deterioration in funding levels since the start of the year, owing to general falls in bonds yields over the period which will have pushed up liabilities.

The long goodbye

Prime Minister David Cameron has signalled his intention to resign, and hand the job of negotiating the exit over to his successor.  It is unlikely that the UK will formally notify the EU of its intention to exit much before the end of the year.  The UK will need to comply with EU rules until it actually exits – which could take some years.

Issues such as VAT on pension scheme costs are therefore unlikely to go away.  The UK could even potentially need to implement the new pensions directive, which has finally been agreed.

Employers and trustees currently running cross-border schemes could potentially need to restructure their schemes.  It may not be possible to carry on running the scheme as before, depending of course on the terms of the UK’s exit.

"Uncertainty is nothing new for those involved in funding pension schemes"

A majority of Scottish and Northern Irish voters voted to remain in the EU.  The geographical split has already led to calls for a fresh Scottish independence referendum, and consideration of the Irish border – even, if highly unlikely, secession of the City of London.  Any carve-up of the UK would lead to issues for pension schemes with members in different regions.

Can the UK 'take back control'?

Control over the rules and regulations that affect UK businesses was a key plank of the platform for the Leave campaign.  While some regulation impacting pension schemes originated in the EU, much is now enshrined in UK law and it is unlikely to be repealed.

Formerly contracted-out schemes will be aware of the government’s plans to require schemes to equalise pensions for the effect of unequal Guaranteed Minimum Pensions (GMPs), designed to replace unequal state benefits.  This issue is unlikely to become a priority for the government in the aftermath of the Leave result, and it has been suggested that given one of the drivers for this change is coming from Europe that this may even be dropped completely.

Uncertainty is nothing new for those involved in funding pension schemes.  As with all other risks, trustees and employers should seek to understand the risks associated with the UK leaving the EU.  Where possible, these risks can then be monitored, managed, or mitigated

Rowan Harris contributed to the writing of this blog post