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Pension scheme accounting deficits were £69bn at 30 April 2012, broadly unchanged for the second consecutive month
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This corresponds to a funding ratio of assets over liabilities of 88%
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Low interest rate environment prompting changes such as reviewing and lowering the level at which interest rates are being hedged
Mercer’s Pensions Risk Survey data shows that the accounting deficit of FTSE350 defined benefit pension schemes in the UK remained broadly unchanged over the month of April. According to Mercer’s latest data, the estimated aggregate IAS19 deficit[1]for the defined benefit schemes of the FTSE350 companies stood at £69bn (equivalent to a funding ratio of 88%) at 30 April 2012. This corresponds to a deficit figure of £70bn at the end of March (funding ratio of 88%) and a figure of £61bn at the end of December 2011 (funding ratio of 89%)[2].
Over the month, corporate bond yields and the market’s view of long-term inflation, which are both used to value the liabilities, remained broadly unchanged with liability values reducing marginally to £566bn as at 30 April 2012. This was offset by a small reduction in asset values (to £497bn as at 30 April 2012) so that the funding ratio and deficit remained broadly unchanged over the month.
“From one perspective the relative stability we have seen in funding levels over the last three month ends is welcome. However if this is an early sign that the low yield environment (for both government bonds and corporate bonds) may be with us for some time, then companies and pension scheme trustees may need to think more about how this might impact scheme funding, particularly in light of the statement released by the Pensions Regulator last week”., said Ali Tayyebi, Senior Partner and Pension Risk Group Leader.
With continued low interest rates careful consideration is also being given to the levels at which pension schemes protect themselves from future changes in interest rates (through interest rate ‘hedging’). Most schemes do not fully hedge interest rates and so are exposed to further interest rate falls, but need to balance the potential gain from rising interest rates (which would reduce the value of liabilities) against the risk of further interest rate falls (which would further increase the value of liabilities). There is evidence that trustees are willing to carry out interest rate hedging at lower interest rate levels than has previously been the case.
Adrian Hartshorn, Partner in Mercer’s Financial Strategy Group commented, “Companies and trustees require a combination of contributions and investment return to achieve their long term funding goal. As market conditions have changed so have the relative risk-reward trade-offs, leading many companies and trustees to review investment strategy to ensure the mix of assets between growth assets and liability matching assets remains optimal. Additionally, uncertainty about economic growth and government debt levels are adding to the risk reward dynamic. This is likely to lead to continuing volatility in markets so that companies and trustees need to consider future economic scenarios when setting investment strategy.”
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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