Out-Law News 2 min. read
07 Jan 2015, 4:54 pm
Data gathered as part of Mercer's Pensions Risk Survey showed that the combined deficit of these schemes increased substantially every month in 2014, from a starting point of £56bn recorded at the end of 2013. As of the end of 2014, the schemes analysed were 85% funded with assets of £608bn and liabilities of £715bn; meaning that they could pay 85% of the benefits promised to members if required. Schemes analysed accounted for around 50% of all UK pension scheme liabilities.
Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that DB pension schemes were continuing to struggle despite improvements in the economic climate more generally.
"The problem is that the way actuaries calculate the level of assets a DB pension scheme needs to pay the benefits is based on yields from bonds and gilts," he said. "And those yields continue to remain at record lows as a result of quantitative easing. However successful the investment strategy DV schemes may have been pursuing, the level of assets they need just keeps going up."
DB schemes promise a set level of pension once an employee reaches retirement age, no matter what happens to the stock market or the value of the pension investment. Many of these schemes switched from equity investments to investments in more secure gilts, or government bonds, and corporate bonds following the 2008 financial crisis. These investments tend to be more secure; however, this means that DB pension fund assets are now much more sensitive to changes in the bond market.
The UK government's programme of quantitative easing (QE) and the long-term low interest rates that followed the financial crisis have effectively pushed up the price of bonds meaning that the 'yield', or return, on those bonds has fallen as a percentage of the price. Lower gilt yields and long-term interest rates also affect a formula known as the 'discount rate' which is used by the pension scheme actuary to calculate the scheme's liabilities during its regular valuations.
Ali Tayyebi, a senior partner in Mercer's retirement business, said that there had been a "huge variety of global financial and economic factors" affecting yields in 2014 and that the company expected "continued volatility" this year. However, the research also showed that difficult market conditions were not preventing schemes from risk management activity: the value of liabilities mitigated through buy-out insurance and longevity swaps reached its highest-ever level last year, he said.
"Whilst the recent fall in yields may cause pension schemes to review the hedging of their interest rates, schemes should be open to the opportunities that volatility provides," he said. "Companies and trustees should be prepared."
The percentage of DB pension schemes that remain open to new members has fallen dramatically since 2007, as employers struggle to cope with the costs of providing pensions for longer against poor investment results. New pension schemes and those used for automatic enrolment tend to be defined contribution (DC) schemes, in which the value of the benefits paid depends on the performance of the underlying investment.
Earlier this week, the Daily Telegraph reported that retailer Tesco was considering whether to close "one of the last DB pension schemes in the private sector" to new members. The Tesco scheme has over 350,000 members, including 203,000 active members of staff; and liabilities of more than £11bn, according to the newspaper.
"The impetus to review options available to [pension scheme] members has also increased in light of the new DC flexibility available from April," said Adrian Hartshorn, a senior partner in Mercer's financial strategy group. "As a result, there is likely to be further evolution in the DB pensions market over the coming 12 months as companies seek opportunities for cost and risk mitigation."