Mercer’s Pensions Risk Survey data shows that the accounting deficit of defined benefit pension schemes in the UK increased over the month of July. 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 87%) at 31 July 2012. This compares to a deficit figure of £70bn[2] at the end of June (funding ratio of 88%) and a figure of £61bn at the end of December 2011 (funding ratio of 89%).
Over the month, long-term market implied RPI inflation fell significantly by around 25 bps, which by itself served to reduce the value placed on scheme liabilities. However high quality corporate bond yields also reduced by around the same amount. A fall in corporate bond yields, which are used to place a value on pension scheme liabilities in company accounts, will increase the value placed on these liabilities, and this more than offset the effect of the fall in market implied inflation. This meant the overall liability value increased by slightly more than 2% over the month to £585bn as at 31 July 2012. Asset values also increased marginally from £501bn as at 30 June 2012 to £510bn as at 31 July 2012, so that the net increase in the deficit was only £5bn.
The increase in liability values also comes despite companies contributing an estimated £1bn-£2bn per month towards pension scheme deficits. “Relatively small changes in investment markets have a very material impact on the financial position of UK pension schemes, more so than the deficit contributions that are being made by companies. This highlights the importance of ensuring the investment strategy (and the risk associated with that investment strategy) is affordable and can be supported by the sponsor’s covenant”, said Adrian Hartshorn, a Partner in Mercer’s Financial Strategy Group.
“The overall deficit is yet again at its highest month end figure for the year so far. This is despite July being one of the best months so far in terms of increases in asset values and long-term market implied inflation falling to its lowest point since a brief period towards the end of 2008. The fall in corporate bond yields has been broadly tracking the fall in gilt yields over the year but corporate bonds yields fell more significantly during July. This highlights the highly dynamic environment and windows of opportunity which may open up or close quickly for risk mitigation actions. The relatively high yield spread on corporate bonds over recent months has increased the relative attractiveness of some liability hedging options, for example partially insuring a pension scheme’s liabilities through an insurance policy or capturing the higher corporate bond yield through direct investment in corporate bonds. In the current environment, reduced levels of inflation might mean that more schemes take the step to increase their level of inflation hedging. With the level of swings seen in recent months in the parameters which drive the relative attractiveness of various options, being prepared to act quickly is key.” said Ali Tayyebi, head of DB Risk in the UK.
Mr Hartshorn, added, “As the difficult pension scheme funding environment continues, new and innovative tools are being brought to the market to support companies and trustees in their funding discussions. It is important for both companies and trustees to assess the range of options available as they move forward in managing the pension scheme’s finances.”
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.
|
