- A recent report by a firm of consulting actuaries showed that the combined asset values of 200 of the UK’s largest, privately sponsored pension schemes fell by £80bn over the past twelve months. However, this fall in asset values has been offset recently by two factors. First because of the fall in break-even inflation rates over the last year, because pension consultants use these break-even inflation rates to project the uplift on inflation-linked pension promises. The consultants estimated that the fall in break even inflation rates “saved” these final salary schemes around £45bn compared with the start of the year.
- But there was more good news. The credit crisis has led to an understandable increase in the required yield in corporate debt. The accounting standard IAS19 recommends that pension liabilities be discounted using the prevailing yields on AA-rated sterling corporate debt. The consultants' report that this benchmark yield has risen from 5.75% to 7.75%, which in turn means that the present value of the liabilities of a typical scheme have fallen too. As a rough rule of thumb for many schemes, a 1.0% rise in the discount rate will lead to a 20% fall in the present value of scheme liabilities. The report estimated that the rise in AA-rated £ yields since the start of the year has “saved” the 200 schemes in their sample £60bn.
- This is obviously fantastic news for pension fund trustees who have been struggling with scheme deficits that have resembled a Gordian knot of a problem since the start of this century. So perhaps they can relax ? Sadly not. These savings are not what they seem. They are accounting-based savings. And one should always be wary of an accountant that comes bearing gifts.
- The rise in corporate bond yields and the falls in break even inflation rates are nothing to celebrate for UK pension funds – even if the accountants say that they are. They reflect the markets’ assessment of the likelihood of the UK experiencing a significant period of lower economic and profits growth, along with higher levels of corporate bankruptcies.
- We look at the possible impact of a decade of low economic growth on the finances of UK DB pension schemes – similar in nature to the “lost decade” of growth experienced by Japan in its period of deflation. The results are not as comforting as the “headline” accounting improvement would suggest – in fact, quite the opposite.
- If this does turn out to be our economic future then the problems faced over the last few years by pension fund trustees, pension sponsors, the PPF and the Pensions Regulator will seem like a picnic in comparison to the ones that lie ahead.
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