• Pension scheme accounting deficits were £75bn at 31 January 2013, corresponding to a funding ratio of assets over liabilities of 88%.
• The increase in the market’s expectation for long-term retail price inflation, resulting from the Office of National Statistics’ decision to keep the RPI calculation unchanged, was a major contributor to an increase in the value of pension liabilities over the month
• As a result pension deficits increased by £13bn (compared to a deficit of £62bn at 31 December 2012, despite the FTSE100 index increasing by nearly 6.5% over the month
Mercer’s Pensions Risk Survey data shows that the accounting deficit of defined benefit pension schemes in the UK increased over the month of January. According to Mercer’s latest data, the estimated aggregate IAS19 deficit[1] for the defined benefit schemes of the FTSE350 companies stood at £75bn (equivalent to a funding ratio of 88%) at 31 January 2013. This compares to a deficit figure of £62bn at the end of December 2012 (funding ratio of 89%).
Over the month there has been a significant increase in market implied long-term retail price inflation which serves to increase the value of future pension liabilities. This has been partially offset by a smaller increase in corporate bond yields. The net effect was an increase in the IAS19 value of pension scheme liabilities over the month, from £588bn to £610bn. Asset values also increased from £526bn at 31 December 2012 to £535bn at 31 January 2013, which has offset some of the increase in the value of liabilities.
“On 10 January the ONS announced that it did not recommend any material change to the RPI calculation. Immediately after this announcement we reported that pension deficits were estimated to have increased by £20bn. This reflected an increase of approximately 0.3% in the market’s view of long-term RPI inflation. Based on subsequent market movements there have been further increases in market expectations for long-term inflation. Increases in equity values and in corporate bond yields have only served to partially dampen the increase in the deficit. This will be frustrating for many as the strong rise in equity values by itself may have raised thoughts about “locking-in” some of those gains if it were not for the fact that this has not come thorough in overall improvements in the funding position” said Ali Tayyebi, head of DB Risk in the UK.
“Given the uncertainty generated by the ONS consultation there were a number of clients that implemented an inflation only hedge in the fourth quarter of 2012 which has allowed them to lock into what now appear to be very attractive rates of inflation. Any risk management action does however need to reflect the scheme and company specific circumstances, so it would be wrong to suggest any particular hedging option was correct for all schemes; a scheme specific analysis and framework is needed to support active decision making. Any framework could for example be based around firstly understanding the overall risk and the different components of risk, understanding whether the risks can be tolerated or are required and then taking actions to either efficiently manage the risk or to mitigate the risk,” said Adrian Hartshorn, partner in Mercer’s Financial Strategy Group.
Mercer’s data relates 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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