U.S. defined benefit pensions were not the only ones suffering in July. According to Mercer’s Pensions Risk Survey, the accounting deficit of defined benefit pension schemes in the United Kingdom over the month of July, with the estimated aggregate IAS 19 deficit for the defined benefit schemes of the FTSE350 companies standing at £75 billion, which is a funding ratio of 87 percent.
This compares to a deficit figure of £70 billion at the end of June for a funding ratio of 88 percent. The deficit was actually £61 billion at the end of December 2011, for a funding ratio of 89 percent.
Over the month, long-term market implied RPI inflation fell significantly by around 25 bps, which by itself served to reduce the value placed on scheme liabilities. However, high-quality corporate bond yields also reduced by around the same amount. A fall in corporate bond yields, which are used to place a value on pension scheme liabilities in company accounts, will increase the value placed on these liabilities, and this more than offset the effect of the fall in market implied inflation. This meant the overall liability value increased by slightly more than 2 percent over the month to £585 billion as of July 31. Asset values also increased marginally from £501 billion as of June 30 to £510 billion as of July 31, so that the net increase in the deficit was only £5 billion.
“The overall deficit is yet again at its highest month end figure for the year so far. This is despite July being one of the best months so far in terms of increases in asset values and long-term market implied inflation falling to its lowest point since a brief period towards the end of 2008. The fall in corporate bond yields has been broadly tracking the fall in gilt yields over the year but corporate bonds yields fell more significantly during July. This highlights the highly dynamic environment and windows of opportunity which may open up or close quickly for risk mitigation actions.
“The relatively high yield spread on corporate bonds over recent months has increased the relative attractiveness of some liability hedging options, for example partially insuring a pension scheme’s liabilities through an insurance policy or capturing the higher corporate bond yield through direct investment in corporate bonds. In the current environment, reduced levels of inflation might mean that more schemes take the step to increase their level of inflation hedging. With the level of swings seen in recent months in the parameters which drive the relative attractiveness of various options, being prepared to act quickly is key.” said Ali Tayyebi, head of DB Risk in the UK.
Mercer’s data relates only to about 50 percent of all UK pension scheme liabilities and analyzes pension deficits calculated using the approach companies have to adopt for their corporate accounts.