• Pension scheme accounting deficits were £55bn at 31 October 2012, corresponding to a funding ratio of assets over liabilities of 90%.
• This represents a £13bn increase in the deficit over the month from £42bn (funding ratio of 93%) as at 30 September 2012.
• The increase in the deficit is mainly due to an increase in the market’s expectation of long-term price inflation.
Mercer’s Pensions Risk Survey data shows that the accounting deficit of defined benefit pension schemes in the UK increased over the month of October. According to Mercer’s latest data, the estimated aggregate IAS19 deficit[1] for the defined benefit schemes of the FTSE350 companies stood at £55bn (equivalent to a funding ratio of 90%) at 31 October 2012. This compares to a deficit figure of £42bn at the end of September (funding ratio of 93%) and a figure of £61bn at the end of December 2011 (funding ratio of 89%).
Over the month, the main change was an increase in market expectations for long-term inflation (measured using the difference between fixed and index linked gilt yields). The effect of this was to increase the liabilities by nearly 3% over the month from £560bn to £575bn. Asset values increased very marginally from £518bn at 30 September 2012 to £520bn at 31 October 2012 to slightly offset the increase in the liabilities.
“October has reversed more than half of the gain which was made during September, with funding levels now falling back to broadly the levels seen mid year. The outlook for long-term RPI inflation has increased again after the sharp decline during September, following the Office of National Statistics announcement of a consultation regarding the future calculation methodology for the RPI. It remains to be seen how much of the ultimate change the market is currently factoring into its outlook.” said Ali Tayyebi, head of DB Risk in the UK.
Mercer and the Institute of Chartered Accountants in England and Wales (ICAEW) recently carried out a survey of senior finance professionals at large UK companies on their attitudes to dealing with defined benefit pension risk. In the report, ‘Living with Defined Benefit Pensions Risk’, a key message emerging was the need for trustees and companies to work together to take advantage of market opportunities if certain scenarios arise.
“The ONS review of RPI and the range of outcomes which could arise represent a potential real opportunity to put this into practice,” said Adrian Hartshorn, partner in Mercer’s Financial Strategy Group. “Some of the more far-reaching changes being contemplated may not be reflected in current market pricing. If for example changes to RPI result in it being reduced close to the CPI calculation then this could lead to sharp adjustments – affecting both pension scheme assets and liabilities to differing degrees. For many, but not all, this may have a materially favourable impact on the funding position of their schemes. In turn this might mean that de-risking, say for example by increasing the level of inflation-hedging, becomes more desirable. Governance structures need to be in place to take advantage of any potential window of opportunity.”
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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