The accounting deficit of defined benefit pension schemes in the United Kingdom increased in January, according to the latest data from Mercer.
Mercer's Pensions Risk Survey found that the estimated aggregate IAS19 deficit for the defined benefit pension schemes of the FTSE350 companies stood at £75 billion, or a funding ratio of 88 percent, at the end of January, compared to £62 billion at the end of 2012 and a funded ratio of 89 percent.
Over the month there has been a significant increase in market implied long-term retail price inflation which serves to increase the value of future pension liabilities. This has been partially offset by a smaller increase in corporate bond yields. The net effect was an increase in the IAS19 value of pension scheme liabilities over the month, from £588 billion to £610 billion. Asset values also increased from £526 billion at the end of December to £535 billion at the end of January, which has offset some of the increase in the value of liabilities.
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"On Jan. 10 the ONS announced that it did not recommend any material change to the RPI calculation. Immediately after this announcement we reported that pension deficits were estimated to have increased by £20 billion. This reflected an increase of approximately 0.3 percent in the market's view of long-term RPI inflation," said Ali Tayyebi, head of DB Risk in the UK.
"Based on subsequent market movements there have been further increases in market expectations for long-term inflation. Increases in equity values and in corporate bond yields have only served to partially dampen the increase in the deficit. This will be frustrating for many as the strong rise in equity values by itself may have raised thoughts about "locking-in" some of those gains if it were not for the fact that this has not come through in overall improvements in the funding position."
Adrian Hartshort, partner in Mercer's Financial Strategy Group added, "Given the uncertainty generated by the ONS consultation there were a number of clients that implemented an inflation only hedge in the fourth quarter of 2012, which has allowed them to lock into what now appear to be very attractive rates of inflation.
"Any risk management action does however need to reflect the scheme and company specific circumstances, so it would be wrong to suggest any particular hedging option was correct for all schemes; a scheme specific analysis and framework is needed to support active decision making. Any framework could for example be based around firstly understanding the overall risk and the different components of risk, understanding whether the risks can be tolerated or are required and then taking actions to either efficiently manage the risk or to mitigate the risk."
Mercer's data relates to about 50 percent of all UK pension scheme liabilities and analyses pension deficits calculated using the approach companies have to adopt for their corporate accounts.
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