Mercer’s Pensions Risk Survey data shows that the accounting deficit of defined benefit pension schemes for the UK largest 350 companies increased over 2013. According to Mercer’s latest data, the estimated aggregate IAS19 deficit for the defined benefit schemes of FTSE350 companies stood at £97bn (equivalent to a funding ratio of 85%) at 31 December 2013 compared to £72bn (equivalent to a funding ration of 88%) at 31 December November 2013. There was however an improvement in the position over the last month of 2013, with the IAS19 deficit reducing from £102bn at 30 November.
“Over 2013 as a whole it has been interesting to see how the three key elements which drive the deficit calculation have independently influenced the deficit,” said Ali Tayyebi, head of DB Risk in the UK. “Deficits increased sharply up to the end of April driven largely by increases in the market’s outlook for long-term market implied RPI inflation. This was driven in part by the market reacting to the 10 January announcement by the ONS confirming that the RPI calculation would not be changed. The position had recovered by mid-year as corporate bond yields increased sharply over Q2 reducing the value placed on pension scheme liabilities. However, a further increase in long-term market-implied inflation and a reversal of some of the increase in corporate bonds yields increased deficits by £20bn over the second half of the year despite the UK stock market returning 10% over that period,” continued Mr Tayyebi.
The value of pension scheme liabilities is calculated in different ways, depending on the purpose of the calculation. The data included in the Mercer analysis is based on publically disclosed accounting liabilities, and, as noted, shows that deficits on this measure have increased over 2013. However, two other important measures of the financial position of pension schemes are showing that deficits have declined over 2013; the funding measure, used by trustees and employers to determine the amount of contributions that need to be paid to schemes; and the solvency measure, used to determine the cost of insuring pension scheme liabilities with insurance companies.
“Based on work that Mercer carries out with clients, evidence suggests a reduction in funding deficits and solvency deficits, even as accounting deficits have increased,” said Adrian Hartshorn, Senior Partner in Mercer’s Financial Strategy Group. ”This highlights the need for employers and pension scheme trustees to understand the distinct elements which drive changes to the funding position that are most relevant to them, and the benefits of a potentially dynamic plan for managing or mitigating these risks.”
“As a result of the improved funding and solvency deficits, there has been an increase in activity to manage and settle liabilities. For example, 2013 saw a return to higher volumes of buyout transactions (the record having previously been set in 2008) a record volume of longevity transactions completed (beating the previous record set in 2011). Mercer was at the forefront of these deals where, in the first 9 months of 2013, we acted as lead adviser in seven buy out deals resulting in premiums of 2.7bn being paid. Mercer has also broken new ground in developing longevity swap solutions such as the Carillion transaction which covered five separate schemes in a single deal and was completed in December 2013. Other significant longevity swap deals were also completed by BAE Systems and AstraZeneca in December 2013”, continued Mr. Hartshorn.
“Looking forward into 2014, there are likely to be further transactions”, said Mr. Hartshorn. “These will likely involve a further transfer of risk to the insurance market through more buy out and longevity transactions. However, there are also likely to be other transactions and exercises implemented by scheme sponsors, such as options that allow pensioners and deferred pensioners additional flexibility in the way they draw their benefits.”
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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