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DISCUSSION PAPER PI-0809

By how much can a diversified approach to investing improve the prospects of reducing a DB pension
deficit ?

Andrew Brigden, Andrew Clare & Shamik Dhar

Following the decline in global equity markets, the rise in bond prices and the downward
revisions to assumed mortality rates between 2001 and 2003, the UK’s defined benefit (DB)
pensions industry went from a situation where surpluses and scheme sponsor contribution
holidays were commonplace, to a situation where fund deficits were the norm. This is the
situation that persists today. In this paper, we present a model of a typical DB pension
scheme, where we take explicit account of the linkages between both sides of the pension
fund balance sheet. We use this model to assess the likely benefits of taking a more
diversified approach to asset allocation compared with the traditional heavy reliance on UK
equities. Our results show that there are clear gains to be had from adopting a more
diversified approach to pension fund asset allocation in terms of the reduction in scheme
funding volatility over time.

Keywords/phrases: Alternative asset classes; diversification benefits; defined benefit
pension scheme; pension fund deficit; asset allocation