The spread of the coronavirus COVID-19 beyond China to the rest of the world has caused a significant downturn in financial markets with many of the larger indexes moving into correction territory, generally, -10% or more, over the past week.
As stock markets tumble, the virus has continued to spread throughout the world with Ireland reporting its first case at the end of February. We look at the effects the virus is already having and the outlook for pensions in a very uncertain market.
As stock markets have fallen since mid-February 2020, the demand for bonds has increased. This in turn has driven yields lower - at the time of writing the yield on the US 10 Year Treasury was 0.914%. Bond yields support annuities and as yields fall the cost of purchasing an annuity, as a secure retirement income, increases. This trend will add to the already beleaguered position of any pension member approaching retirement that is looking to purchase an annuity.
A test for automatic enrolment?
The introduction of automatic enrolment (AE) in the UK has led to an estimated tenfold increase in private pensions. While AE is still at the consultation phase in Ireland, a turbulent market will test the UK’s National Employment Savings Trust, or NEST, which has over 8 million members. This will especially be the case where there are large scale fund switching, withdrawals and members opting to cease contributions to their retirement fund.
A backseat for ESG?
ESG (Environment, Social and Governance) has certainly been topical over the past 24 months. As well as the requirement contained in Article 19 of the IORP Directive for ESG factors, the desire to avoid reputational risk has driven pension schemes to adopt ESG principles when investing. The impact the market downdraft has had on ESG funds since concerns about COVID-19 emerged has been considerable. However, it remains to be seen whether pension investors will continue to prioritise the avoidance of reputational risk over the lure of safe haven assets or funds that may not sit comfortably with ESG principles.
Bad news for defined benefit schemes
A leading UK consultancy firm has estimated that the virus has increased UK defined benefit deficits by over £100bn in the space of a week. The firm also highlighted that, should the virus continue its spread, UK defined benefit deficits could double to almost £900bn by the end of the year. The Irish defined benefit market could expect similar funding movements albeit reflective of the smaller market that exists here.
Obligation to continue paying contributions
In extreme circumstances an employer may decide to temporarily lay off staff due to disruptions in work flow or wider public health concerns arising from the virus. In such circumstances the employer needs to ascertain what obligation arises on it to continue payment of pension contributions during any period of temporary absence. Any decision made by the employer must be carefully consider so as to not fall foul of applicable legislation or the rules of the pension scheme. It is crucial that any decision is adequately communicated to the employees concerned and the administrators of the scheme who are responsible for implementing any such decision.
An epidemic on this scale has not been seen before and its outcome is difficult to predict. The real tragedy is of course the illness and death that the virus brings but we should not ignore the financial consequences that the virus will leave in its wake. There are a number of measures that employers and trustees can take to mitigate against the financial consequences of the virus:
Employer/trustees may need to re-assess plans they have made for their schemes and extend timelines to meet their strategic objectives
Contact should be made with scheme administrators to ensure that vital scheme services can be maintained should the current crisis worsen
Employers who lay off staff on a temporary basis during the crisis need to carefully consider if it is possible to temporarily cease the payment of pensions contributions and whether such action is permissible
Trustees of defined benefit schemes should undertake an assessment of the employer funding covenant to assess options should cash flows weaken
Discussions should be held with actuarial and investment managers to insure the scheme investments are insulated against the full effects of the virus
Teleconferences should be used to facilitate meetings during the duration of the crisis. Scheme documentation should be reviewed to assess if such meetings are permissible