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Mercer’s Pensions Risk Survey shows that the accounting deficit of defined benefit (DB) pension schemes for the UK’s largest 350 listed companies has deteriorated further, with deficits exceeding £100bn at 15 December 2014. This has been driven by record lows in high-quality corporate bond yields, which are used to measure the pension liability reported in company accounts. The lower the interest rate yield used, all else being equal, the bigger the reported liabilities.
On 16 December, AA corporate bond yields, as measured by the markit iBoxx >15 year index, fell to a record low (3.38% p.a.), compared with 4.42% p.a. at the end of 2013. Falling bond yields partly reflect investors’ outlook for economic and productivity growth, which in turn will influence the timing of increases in central bank interest rates and their likely long-term level.
As a result, DB pension liability values have increased to about £720bn (representing an increase of £100bn compared to the corresponding figure at 31 December 2013) and asset values have changed to about £600bn (representing an increase of £40bn compared to the corresponding figure as at 31 December 2013). This means that pension scheme deficits have increased to £120bn (compared with £56bn at 31 December 2013).
Warren Singer, Mercer’s UK head of pension accounting, said:
“For FTSE 350 companies with DB pension liabilities, 2015 profits will be affected by an interest cost that is applied to the deficit position at the start of the year. Given the growth in pension deficits seen over 2014, this interest cost is likely to be at least £1.8 billion higher in 2015 than in 2014, in aggregate. This means that the profits of FTSE 350 companies in 2015 could be at least £1.8 billion lower than in 2014 due to pension costs, all other things being equal.”
According to Ali Tayyebi, Senior Partner in Mercer’s Retirement Business, “Falling bond yields have clearly put DB pension plans under a lot of strain in the latter part of this year. Pension plans with higher levels of assets which hedge the effect of falling bond yields will have fared noticeably better during this period.
“Many of these plans will have increased their allocation to such assets by taking advantage of often short-lived opportunities when market conditions have been more favourable. This emphasises that a more nimble approach to taking advantage of improved conditions should be a key part of the risk management toolkit for every pension scheme.”
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