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
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