Bond yields: unwelcome news for defined benefit pension scheme sponsors

Bond yields are at all-time lows. Notably, long-date corporate bond yields ended the year as low as they’ve been for at least a decade. My handy source of data doesn’t really go back much further, but I wouldn’t be surprised if they’ve never been this low – ever.

 (Source: FT-SE Actuaries indices, Markit iBoxx indices)

This may be great news if you are invested in bonds, but for many defined benefit pension scheme sponsors it is unwelcome news. Unfortunately, pension liabilities on corporate balance sheets should be calculated using a discount rate equal to corporate bond yields. Thus, as yields have fallen, balance sheet liabilities have risen – our friends at Mercer have estimated that overall balance sheet deficits could have doubled over 2014.

Some sponsors may be ambivalent about such balance sheet volatility – taking the longer-term view that what goes up, must come down. But others may be more sensitive, worried about how an apparent weak balance sheet might be perceived by customers, lenders, and possibly even shareholders.

Low corporate bond yields could have other effects. I have a client who pegs commutation factors (the conversion rates used to determine how much pension is reduce by when a member opts for a lump sum on retirement) to corporate bond yields. As yields have fallen, those rates have become steadily more generous – great news for scheme members at retirement, but potentially very expensive for the scheme sponsor. Transfer values are usually linked to bond yields as well, so they too will have become more generous.

Balance sheet volatility may encourage sponsors to try and do a better job of matching assets and liabilities. But trying to match when yields are low means locking in at what feels like precisely the wrong time – unless of course you take the view that in 6 months’ time I’ll still be saying that bond yields are at an all-time low.

John Broome Saunders
Actuarial Director
Telephone: +44 (0)20 7893 3456
Email: contactus [@] broadstone.co.uk

Collapsing yields prompt another pensions crisis

With long gilt yields hovering just above 2%pa, many pension scheme deficits will be looking rather unpleasant.

Since the beginning of 2014, yields have tumbled by over 1.5%pa – that could easily mean a 25% increase in the liabilities of a typical defined benefit (DB) pension scheme. Typical risk asset returns have been moderate at best – UK equities, for example have returned 1.2% over 2014. Some pension schemes may have been able to hedge some or all of their long-term interest rate risk – either by investing in bonds, or using ‘Liability Driven Investments’ (LDI) to match scheme assets with liabilities. But many schemes will not be completely hedged in this way, and will now be suffering from significantly increased deficits – on pretty much any calculation basis.

Looking forward, the prognosis is bleak. With the European Central Bank beginning its own Quantitative Easing programme, there doesn’t seem any immediate prospect of higher yields – indeed, some commentators, think that yields could fall still further.

What should DB scheme trustees do? Fortunately, most only need to get out of bed and worry about how to fund deficits every three years, so many may well pull the covers over their eyes and keep their fingers crossed that, by the time the next valuation comes around, the position is a little better. But those with valuations now are faced with the unpleasant prospect of asking sponsors for more cash. Some sponsors may be able to find a few extra pennies, whilst for others deficit funding may be driven primarily by affordability - in which case there’s probably no chance of extra cash no matter what the actuary says.

Of course, schemes that hedged their interest rate risk a few years ago will be feeling very smug indeed. But hindsight is a wonderful thing.

John Broome Saunders

Actuarial Director

Telephone: +44 (0)20 7893 3456

Email: contactus [@] broadstone.co.uk

Leaving Service - What Happens Next to your pension?

In today’s workplace, the days of a job for life are long since over. Many people will change jobs ten to fifteen times during their working careers. Their workplace pension can become a casualty of these frequent changes, with pension arrangements being made and removed on leaving the employer.

Most of the UK’s leading pension providers follow a standardised process which ensures that the former employee retains their benefits and ceases the pension relationship between themselves and their former employer.

At the time of leaving service with their current employer, employees will receive a leaving service pack which will confirm their options and most likely include a direct debit instruction to continue contributing to their pension personally.

The pension plan is converted by the provider into an individualised arrangement, and once this change has been made both the employer and their engaged financial adviser, both cease any liability or obligation to provide assistance to the former employee.

Starting a new job will most likely result in an additional pension being set up for the employee by their new employer. The employee can then choose to transfer the existing plan into their new arrangement or continue with two (or more) plans. This can create administration issues both during employment and at retirement.

Employee awareness and understanding is therefore vital to this process and it is the responsibility of the employer to ensure that the employee knows what comes next.

Robert Simmons

Corporate Pensions Administrator

Telephone: +44 (0)20 7893 3456

Email: contactus [@] broadstone.co.uk

The importance of a good payroll provider

With the changes in pensions legislation that have occurred over the last few years, the role of the payroll provider has changed in its importance to the company pension scheme. Before they enjoyed something of a backseat role, but now they have been thrust to the forefront of a company’s dealings with its pension provider.

Automatic enrolment has added extra layers of complexity into the process of assessing eligibility, managing the membership, data, and contribution payments for pension schemes.

As with any dealings with an individual or firm, you get out what you put in and with payroll providers it is no different. Employers who bring their payroll providers in to this process early, often find that the teething issues most pension schemes encounter can be greatly reduced.

However it is not just the employer’s responsibility to bring their payroll providers in on the pensions process, it is also the responsibility of the pension providers themselves.  For some it can be as simple as inclusion on regular conference calls, and for others far more specific inclusion and training is required.

Encouraging a greater awareness of the automatic enrolment process on the part of the payroll provider should be the overriding aim of both the employer and the pension provider respectively as auto enrolment becomes more established in workplace pensions.

Robert Simmons
Corporate Pensions Administrator

Telephone: +44 (0)20 7893 3456
Email: contactus [@] broadstone.co.uk