Towers Watson warns that record low bond yields mean that companies are on course to record higher defined benefit pension liabilities in their end-of-year accounts. Pension scheme assets have also grown since the end of 2013, notwithstanding the recent falls in equity markets. However, this has not been enough to stop deficits from widening.
On 15 October, AA corporate bond yields as measured by the iboxx >15 year index fell to a record low (3.54%). High-quality corporate bond yields are used to convert future pension payments into the “pension liability” number that appears in company accounts. The lower the interest rate used, the bigger the liabilities will be. Falling bond yields partly reflect the fact that recent growth and inflation statistics have disappointed compared to consensus expectations, leading investors to reassess both the pace of change and ultimate level of central bank interest rates.
Neil Crombie, a senior consultant at Towers Watson, said: “For the FTSE350 as a whole, liabilities have grown by almost £70 billion since the end of 2013 and shortfalls by more than £20 billion. This has happened even though companies can now budget for smaller pension increases thanks to inflation expectations coming down. How any individual company will be affected will vary a lot, depending on how well-hedged its investments are and how well-funded its scheme was to begin with.”
For this year’s accounts, employers will also have to decide whether to assume that the new choices over how people can access defined contribution pensions will entice a significant number of members to transfer out of final salary schemes before they retire.
Neil Crombie said: “Until now, transfers out of defined benefit schemes have been so rare that companies didn’t have to worry about the precise level – whatever happened would not make a material difference to the numbers in their accounts. Allowing pensioners to access defined contribution pots as and when they like can only lead to transfers becoming more popular, but how much more popular will remain unclear for some time. Most people will want to keep their options open and will only think seriously about transferring once they are close to retirement.
“If a company assumes that a meaningful number of people will transfer out just before retirement, this would usually increase the liabilities that it has to disclose in its accounts: accounting rules would usually place a higher value on a member’s transfer value than his pension. Some companies may therefore prefer to wait until experience of transfer activity under the new regime starts coming through before changing how they calculate their pension liabilities.”
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