Mercer’s Pensions Risk Survey data shows that the accounting deficit of defined benefit pension schemes in the UK increased over the month of November. According to Mercer’s latest data, the estimated aggregate IAS19 deficit[1] for the defined benefit schemes of the FTSE350 companies stood at £61bn (equivalent to a funding ratio of 90%) at 30 November 2012. This compares to a deficit figure of £55bn at the end of September (funding ratio of 90%) and a figure of £61bn at the end of December 2011 (funding ratio of 89%), using a like for like measure.
Over the month, the main changes were a reduction in corporate bond yields and an increase in the market’s expectations for long-term inflation (measured using the difference between fixed and index linked gilt yields). Both of these factors individually serve to increase the calculation of the liabilities and together they increased the liabilities by nearly 2% (or £10bn) over the month from £575bn to £585bn. Asset values also increased from £520bn at 31 October 2012 to £524bn at 30 November 2012 to partially offset the increase in the liabilities.
“As we approach 31 December, which is the effective reporting date for the majority of FTSE350 companies, the unwelcome trend in increased liability values and lack of confidence in investment markets continues. The primary driver of the calculation of liabilities is the real yield on corporate bonds (which is the nominal yield in excess of market implied inflation). This fell to its low point for the year correspondingly increasing the liability calculation to its high point for the year. These same market conditions will also increase the accounting pension expense for many companies leading to lower profitability in 2013, all other things being equal,” said Ali Tayyebi, head of DB Risk in the UK
“In the UK, IAS19 liability values and pension expense figures are calculated using yields on “high quality corporate bonds”. Historically this has almost universally been interpreted as AA rated corporate bonds. For a number of reasons, questions are being raised across Europe about the possibility of extending the bond universe which could be used to derive a high quality corporate bond yield for IAS19 purposes. The impact could be material in some cases with a potential increase of around 0.2% pa in the discount rate in the UK, which could mean a 3% - 4% reduction in the reported liabilities and a reversal of the increase in the 2013 pension expense described above. Across FTSE350 companies, this would translate to a reduction in the deficit of around £20bn. This is very much an issue for discussion between companies, their advisers and their auditors and if companies are minded to explore this further those conversations need to start now, well in advance of the year end. This remains a potentially important avenue to explore as, although the Chancellor’s autumn statement announced a consultation which may ultimately provide some easement to cash contributions payable by companies, its does not affect the deficits and pensions costs reported under IAS19. As such there was nothing here to soften the deteriorating trend on reported deficits” continued Mr Tayyebi.
“As market conditions have changed through 2012 there have been a range of different opportunities for schemes to evolve their investment strategy, both to reduce risk and capture return opportunities. To capture these opportunities requires a streamlined governance approach and regular monitoring of both the scheme’s financial position and the market opportunities. Governance structures continue to evolve with some trustee bodies retaining day to day decision making within the trustee body working closely with their advisers and other adopting a delegated approach where day to day decisions are delegated to a third party,” said Adrian Hartshorn, partner in Mercer’s Financial Strategy Group.
Mercer’s data relates only to about 50% of all UK pension scheme liabilities and analyses pension deficits calculated using the approach companies have to adopt for their corporate accounts. The data underlying the survey is refreshed as companies report their year end accounts. Other measures are also relevant for trustees and employers considering their risk exposure. But data published by the Pensions Regulator and elsewhere tells a similar story.
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