Coronavirus: implications for pensions

Life assurance benefits

Where life assurance benefits are provided, the insurer will often impose a "catastrophe limit" capping the number or value of claims arising out of one cause in order to limit its exposure to mass fatality events.  Employers and trustees who provide insured benefits may wish to check their policy terms and whether the rules of their scheme require benefits to be paid in full even where the pay out under the policy is capped.  They may also wish to consider how policy proceeds should be apportioned if the scheme benefit is capped to the amount paid under the policy.  In the future, they may want to consider splitting members across more than one policy and insurer to reduce this risk.

Defined contribution schemes

In defined contribution schemes the investment and interest rate risk lies with members.  Members who are looking forward to retirement in the near future may defer their retirement if stock market volatility has significantly reduced the value of their pension pots; or if the policy response has led to lower interest rates and made annuities more expensive.  That could, in turn, have implications for employers' workforce planning.

Of course, most members invest their contributions in their scheme's default fund.  This should reduce the impact of market volatility on retirement decisions.  It will be interesting to see how existing default funds stand up to the real world "stress testing" caused by the reaction to the Coronavirus and whether there will be claims from members against trustees where the default fund is found wanting and retirements have to be postponed or pensions are lower than expected.

Defined benefit schemes

Trustees and employers will probably already be aware of the implications for defined benefit schemes.

The employers bear the balance of the cost of funding the benefits after allowing for investment return and any employee contributions. Scheme trustees have a duty to review from time to time the strength of the employer covenant, namely the employer's ability and willingness to support the scheme in meeting the scheme's liabilities.

Coronavirus is likely to weaken significantly the employer covenant (in the short term, at least) in certain sectors of the economy such as travel, entertainment and hospitality. Where this is allied to existing significant challenges for businesses, scheme trustees need to be alert to potential financial distress for the sponsoring employers and may need to seek additional security in some cases.  Any permanent weakening of the covenant will likely lead to a tightening of technical provisions at the next valuation.

The Coronavirus may have a dampening effect on the economy and could potentially lead to recession. Global stock markets have already suffered significant falls. There could be downward pressure on interest rates and therefore on gilt yields, whether this results in actual cuts in interest rates or deferring any future interest rate rises, with an impact on the discount rate used in valuations.  So deficits may increase – or not reduce as planned. The impact, of course, will vary from scheme to scheme – some may be well hedged against interest rate falls – and there may be some countervailing impact from increased mortality amongst members.

If the Coronavirus is not a one-off event and recurs in some form in future years, it might lead to weaker mortality assumptions in actuarial valuations, which would, of course, improve the funding position of defined benefit schemes.