The defined benefit (DB) pension market is currently at a “crossroads” as many schemes are now well-funded, Mercer has said.

The firm’s pensions risk survey data has found that the accounting surplus of DB pension schemes for the UK’s 350 largest listed companies decreased by £2bn month-on-month to £52bn at the end of August.

Furthermore, Mercer’s analysis of the FTSE 350’s DB pension schemes found that the present value of liabilities also decreased from £583bn at the end of July to £576bn at the end of August, which has been driven by a rise in corporate bond yields, offset by a rise in market-implied inflation.

Asset values also decreased from £637bn to £628bn in the same period.

With many schemes now well-funded, Mercer has said that some trustees and sponsors may be faced with a buy-out dilemma and need to weigh up the opportunity cost of an insurance transaction versus the alternatives.

Global DB segment leader, Graham Pearce, said: “The UK DB pensions market finds itself at a crossroads, as many schemes are nearing the funding level needed to secure benefits with an insurer.

“As more DB liabilities move to the balance sheets of a smaller group of insurers, it is important to think through the implications of this change in how the UK delivers DB pensions. In other parts of Europe, consolidation into large, robust and well-governed vehicles has generally been preferred to the buy-out route. Many of those are operating like insurance companies, making appointments to bring their standards of governance in line with insurers. Under a consolidation approach, pensions can potentially be financed with a healthier risk appetite than can be tolerated by an insurer, which can lower the cost of pension provision.”

The Government has suggested that there is potential for “DB schemes to work harder for members, employers and the economy” and it is currently gathering evidence on options for DB pension schemes, including on the role of consolidations.

Strategic risk management leader for Europe, John O’Brien, added: “The cultural and legal backdrop for pensions can vary hugely. While comparison of risk transfer patterns with the UK is informative, it does not always tell the entire story. In many countries, there is simply no active risk transfer market. Pension plans have little option but to soldier on. Where risk transfer markets do exist, developed countries tend to have confidence in the insurance regime. But the reality is nobody knows where politics could take that regulation over time. As history has shown, there can be political gain in relaxing regulation when memories of past financial crises fade.

“The UK is fortunate to have markets for risk transfer and alternatives which coexist, challenging one another. Risk transfer to insurance companies will be the decision made for many schemes but, for the sake of financial stability and member outcomes, it’s a decision which shouldn’t be reached without that challenge.”

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