• Despite asset value growth and £20 billion of contributions, liabilities reach another high point for the year
• Pension scheme accounting deficits were £62bn at 31 December 2012, corresponding to a funding ratio of assets over liabilities of 89%.
• This means that the deficit position has remained virtually unchanged compared to the start of the year (deficit of £61bn as at 31 December 2011), despite companies paying in contributions of around £20bn during 2012
• 31 December 2012 represented the high point of the year for both assets and liabilities suggesting both risks and opportunities lie ahead.
Mercer’s Pensions Risk Survey data shows that the accounting deficit of defined benefit pension schemes in the UK increased very marginally over the month of December and for 2012 as a whole. According to Mercer’s latest data, the estimated aggregate IAS19 deficit[1] for the defined benefit schemes of the FTSE350 companies stood at £62bn (equivalent to a funding ratio of 89%) at 31 December 2012. This compares to a deficit figure of £61bn at the end of November (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 corporate bond yields increased and this by itself tends to reduce the value placed on scheme liabilities. However this positive effect was more than offset by the effect of an increase in market implied long-term inflation (measured using the difference between fixed and index linked gilt yields). As a result, the value of scheme liabilities increased marginally over the month, from £585bn to £588bn, reaching another high for the year. Asset values also increased from £524bn at 30 November 2012 to £526bn at 31 December 2012 to partially offset the increase in the liabilities.
Over 2012 as a whole, the yield on corporate bonds reduced quite substantially. This decrease in corporate bond yields was not matched by a decease in market implied inflation so that liability values over 2012 increased from £548bn to £588bn. Asset values increased from £487bn to £526bn. Part of this increase in asset values was as a result of around £20bn of contributions being paid by UK companies and part of it was from asset growth.
“On the surface it appears to have been a fairly flat year with deficits remaining broadly unchanged compared to 31 December 2011. However that masks the volatility experienced during the year and the fact that the year has ended with both assets and liabilities at their high point. This suggests that, as much as ever, there may be opportunities as well as risks which should be prepared for.” said Ali Tayyebi, head of DB Risk in the UK at Mercer.
“There are four questions which anyone responsible for DB Risk management should address as part of their New Year resolutions,” continued Mr Tayyebi.
According to Mercer the questions are: How do I measure risk? What scenarios represent the key risks and risk management opportunities for my pension scheme in 2013? What actions could be taken when those opportunities arise? How do I monitor the position and ensure all stakeholders are prepared and aligned to take those actions?
“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 enhance return. Trustees need to set aside time to understand which risks they are exposed to, the opportunities available, the sponsor’s views on these risks and opportunities and the cost of risk mitigation. Only once these issues are understood can trustees put in place a plan to manage risk and capture opportunities. Furthermore, to capture these opportunities requires a streamlined governance approach and regular monitoring of both the scheme’s financial position and the market conditions,” said Adrian Hartshorn, partner in Mercer’s Financial Strategy Group.
“In 2013 we are likely to see a continued focus on schemes developing financial management plans, with particular emphasis on options that can be implemented cost effectively, for example; the use of special purpose vehicles or contingent assets to enhance member security, support funding plans and preserve cash contributions; offering additional options for retiring members to enhance flexibility and manage scheme liabilities; selectively hedging interest rate or inflation risk at durations where it is attractive to do so; and ensuring efficient investment of assets to optimise the risk/return trade-off,” continued Mr Hartshorn.
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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