By Ali Tayyebi
Continuing the general trend for 2016, August was a particularly awful month for pension scheme deficits.
Mercer’s estimate of the FTSE 350 aggregate pension scheme deficits reported in company accounts increased by £50bn during August alone, meaning that since the end of February deficits have grown from £49bn to £189bn as at 31 August, despite a £90bn increase in asset values. And this is just across the FTSE 350 – the trend is reflected across UK plc as a whole, albeit individual schemes have fared very differently depending on their investment strategies.
The dominant theme has been the dramatic fall in the yields on government and high quality corporate bonds. Most recently this followed the Brexit vote and subsequent policy responses, notably the Bank of England’s announcement to cut interest rates and extend quantitative easing.
As the longer term impact of the Brexit vote gradually reveals itself, companies and pension scheme trustees are slowly realising this may not be just a transient phase and that today’s world could be the new norm. The increased pension scheme deficits and the pressure this will create for increasing company contributions has received much attention in recent weeks with deficits reaching record highs. Less obvious immediately, is the increased cost of continued defined benefit (DB) accrual for those still enjoying that form of benefit.
Companies will be under pressure to demonstrate how they are managing the cash implications of pension scheme deficits, but also importantly how they are getting their arms around the continued risks going forward. Trustees will want the comfort they need on improving the security of benefits while still typically relying in big part on the continued health of the sponsoring company.
There are no silver bullets but progress can definitely be made and putting your destiny in the hands of hope is not the answer. One of the key areas of common ground for most companies and trustees will be to really examine the scope to reduce risk in the short to medium term in a way which does not increase the size of the deficit or the contribution requirements.
More specifically, schemes will need to consider the scope for: reducing risks which have a low conviction of being rewarded; taking advantage of non-gilt assets which provide both a higher level of return, high levels of security, and close matching of the scheme’s liabilities; examining the extent to which the margins of prudence in the discount rate underpinning the cash funding requirements may be inhibiting the scope to reduce investment risk; and other means of pro-actively managing the liabilities and risks – such as carefully managed member option exercises.
What seems clear is that we are in a very different world today than that of 2015. A reversion to that prior world seems most unlikely for the time being and those schemes that re-test their funding and investment strategies against the new norms will be those that enter the next world in the best shape.
Ali Tayyebi is a senior partner in Mercer’s Retirement Business
