The recent QE announcement by the ECB has pushed bond yields lower, further increasing defined benefit pension scheme liabilities. Mercer’s Pensions Risk Survey data shows that the accounting deficits of defined benefit pension schemes for leading semi-states and the companies listed on the Irish Stock Exchange had already increased to an estimated €10 billion by the end of 2014, a 40% increase over the year. In the immediate term, yesterday’s announcement will further increase liabilities and, in many cases, deficits. The impact on deficits may be limited where schemes have adopted a de-risking strategy.
The impact of QE, including falls in bond yields and the weakening of the euro, will cause further challenges for plan sponsors and trustees alike. Funding proposals, already facing pressure, may go off-track and need to be re-cast. It is imperative that plan sponsors and trustees consider whether their existing investment strategy is appropriate in the current environment. Alternative asset classes may now be more attractive given the increase in the cost of buying bonds. In addition, hedging strategies, including currency hedging given the ongoing weakness of the euro, should be reviewed. A dynamic risk management strategy and regular monitoring framework is ever more important.
The impact on DC schemes, while less visible, should not be ignored. DC members approaching retirement may find that the cost of buying an annuity is more expensive than anticipated. In practice, the flexibility of DC schemes now means that many members do not need to purchase an annuity and instead choose to invest in an Approved Retirement Fund (ARF). These members will need to consider what role bonds should play in their investment strategy both before and after retirement.
Sean O’Donovan, Head of DB Risk, Mercer commented “The QE programme announced yesterday has added further uncertainty and complexity to pension schemes. This highlights the importance of a strong risk management ethos in DB schemes, with an ability to react quickly to changes in market conditions. From a DC perspective, trustees should urgently review the funds available to members and ensure that they remain appropriate in this changed environment.”