A new approach to how pensioner liabilities are financed and valued in defined benefit (DB) schemes could generate £40bn in extra value, according to analysis by PwC.

Undertaken in response to The Pension Regulator's ongoing DB funding regime consultation, the analysis found that improved funding is possible if schemes avoid pension liabilities being too closely tied purely to gilt investments.

It stated that instead, the "real need for pension schemes" is to match the annual outgoing cashflows each year as they pay pensions, supported through a diversified portfolio of cashflow-matching bonds and other low-risk income-generating investments.

PwC global head of pensions, Raj Mody, argued that the pensions industry has been "shoe-horned into an undue focus" on referencing back to gilts, as a "so-called risk-free benchmark".

The firm revealed that, over the last decade, pension scheme investment in gilts has almost doubled, from 23 per cent to 45 per cent of their assets, while the proportion of pension funds related to paying current pensioners is 40 per cent.

It highlighted this as evidence of a "drift" towards using gilts, arguing that this, in part, has been driven by having rules and regulations framed around gilt yields.

Mody added: “While that doesn’t stop individual schemes doing their own thing, the trouble with this kind of reference point is that it creates a herd mentality.

“This then puts pressure on trustees or companies looking to follow a more bespoke approach, even if it’s a better strategy for their own pension scheme.”

In light of the findings, PwC has emphasised the need for any parameters underpinning the new funding regime to be flexible enough to avoid a need for pension schemes to back their pensioner liabilities with gilts.

It argued that forward-looking parameters should focus on the cashflow obligations of the scheme, with flexibility to find the best assets to meet those cashflows, rather than focusing on a "single-point valuation" of the liabilities, and comparing this to a "single-point asset number".

Mody continued: “Even previous funding regimes have recognised the need to treat the funding of existing pensioner liabilities with caution.

“The Minimum Funding Requirement introduced in 1997 had a special concession for valuing large groups of pensioners.

“If anything, the need for something like this is now more acute. Pension schemes are now doing exactly what they exist for - to pay out retirement incomes.

“But that makes it all the more important to get the new funding framework right, both for existing and future pensioners.”

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