This year’s PwC’s Pension Support Index score of 82 out of a possible score of 100 is the same score as 2006. The Index tracks the relationship between the financial strength of FTSE350 companies and their defined benefit pension obligations.
Continued low gilt yields, often used to value pension liabilities, have prevented an improvement in the index in recent years. The question of support for pension schemes has become increasingly important in light of changing market conditions. This is exacerbated by the current uncertainty over the long-term implications of ‘Brexit’.
The index also shows a polarisation, with twice as many companies as in 2006 supported by a weak covenant. The winners over the period appear to be those schemes that have hedged out much of their risk and therefore have not been impacted to the same degree by market shocks – in particular, interest rate falls.
The implications of Brexit on pension schemes and companies is still to be seen, but the further fall in gilt yields since the referendum result was announced illustrates how important it is for companies and trustees to really understand the capability of the sponsor to withstand shocks to the pension scheme.
Jonathon Land, pensions credit advisory leader at PwC, said: “Following Brexit, trustees and companies need to understand how their particular employer will be impacted in future. There will be winners and losers – you need to know which group you are in and what to do about it.
"If you have a strong covenant and can support further shocks, there is the option to take a longer term view and you may well benefit if rates revert to long-term averages. However, if your covenant is weaker, de-risking and/or using a contingent asset would appear to be a better approach. Our analysis of the FTSE 350 over the last ten years would certainly support this view.
"Time is running out for trustees and sponsors that have been waiting for gilt yields to rise. The key question for those who have kept their interest rate exposure is whether the sponsor covenant can withstand the downside if gilts fall further.”
Jeremy May, pensions partner and actuary at PwC, said: “In their last valuations, many sponsors and trustees expected gilt yields to rise, which would in turn reduce pension deficits. However, the expected rise in yields has consistently failed to appear.
“The question for trustees and sponsors now is whether or not they can continue with the volatility that has been hitting pension schemes over the decade. An alternative strategy would be to recognise that repairing the deficit needs to be done over a longer time frame – this would allow trustees to reduce the investment risk within the scheme by moving to more cash generative assets whilst increasing liability hedging with the sponsor, thereby benefitting from the reduced volatility in future contribution calculations.”
Andrew Sentance, PwC’s senior economic adviser, said:
“Interest rates are not expected to rise much before the 2020s, and looking even further ahead, long-term gilt yields are likely to be low. But there is another scenario where central banks do normalise rates in the 2020s and real interest rates rise. Pension schemes should not lose sight of this scenario.
“Brexit may have impacted the short-term, with rates staying lower for longer. However, the medium- to longer-term view has not changed substantially.”
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