Defined benefit pension deficits for the ISEQ constituents have decreased by approximately €1.4bn from €2.5bn to €1.1bn over 2017, according to data compiled by Mercer. This reflects a generally positive year for defined benefit scheme funding levels, with a combination of higher corporate bond yields and positive asset returns reducing corporate accounting deficits.
Discount rates, used by companies to value their pension schemes which are based on corporate bond yields, rose by approximately 0.2% for the average scheme, decreasing liabilities by 3% year on year. This, coupled with positive returns on the majority of asset classes, which have generally ranged between 3% and 5%, has delivered a positive impact for the health of defined benefit pension schemes in 2017, and contrasts with 2016 where declining bond yields helped drive deficits up by €1.5bn.
Peter Gray, Senior Consultant with Mercer’s Strategic Solutions Group, commented, “2017 has seen the overall deficit at Irish listed companies decrease by c.€1.4bn due to an increase in corporate bond yields. With liabilities in excess of €20bn, even a relatively modest increase in bond yields can have a substantial effect on reported deficits. Further adding to the good news from the schemes perspective is that the rise in yields has not coincided with a rise in inflation expectations, which remain somewhat subdued”
Corporate bond yields rose sharply over the first two quarters of 2017 reducing the value of defined benefit liabilities. Although this rise has been somewhat reversed in the following months, year-end discount rates remain above their position at the beginning of the year. While yields have risen, and this will be welcomed by all those associated with defined benefit schemes, they remain close to all-time lows. The low yield environment is, in part, being driven by the ECB quantitative easing programme and with quantitative tightening on the horizon there will be many interested parties monitoring the impact on yields.
It has been a strong year for growth assets, boosted by strong economic growth and improving corporate profitability. Equity markets have demonstrated remarkable fortitude, taking geopolitical shocks like Brexit in their stride. The MSCI EMU (European Monetary Union) Index, against a backdrop of positive economic data, returned an impressive 13% year on year.
Even with the uncertainty created by Brexit, the Eurozone is finally showing stronger growth, thanks to increased consumer confidence, falling unemployment and accommodative monetary policy from the ECB. Growth is also relatively strong in the US, Canada and Japan, demonstrating the increased level of synchronized growth globally.
Many employers with defined benefit schemes have taken action to reduce their pension risk with many electing to close their schemes to future accrual of benefits and running risk reduction programmes such as Enhanced Transfer Value (ETV) exercises and bulk purchase annuities. It will be important for sponsors and trustees to consider whether improved funding levels are an opportunity to de-risk their schemes, if they can afford to do so.
“Despite the modest rise of interest rates we remain in a low-yield environment which can make it difficult for trustees to de-risk. However, as we enter the latter stages of the global economic cycle significant tail risks on the asset side mean the opportunity costs of inaction may translate into the need for further sponsor contributions. Market conditions could change rapidly and opportunities to protect schemes’ funding levels against future volatility exist. It is important that trustees and sponsors are in a position to capture these opportunities to solidify the funding level improvements we have seen this year” commented Mr. Gray.
He added, “Trustees and sponsors should establish a robust risk management framework and consider all the tools available to them, including non-traditional measures such as equity downside protection, interest rate and inflation hedging, or the use of contingent assets, to offer greater protection for members while higher allocations to growth assets are maintained”.
Notes for the Editor
The value of pension scheme liabilities is calculated in different ways, depending on the purpose of the calculation. The data included in the Mercer analysis is based on publically disclosed information using the approach companies must adopt for their corporate accounts. The data underlying the analysis is refreshed as companies report their year-end accounts. Other measures are also relevant for trustees and employers considering their risk exposure.