- Defined benefit pension deficits for the ISEQ constituents increased by approximately 50% from €3bn to €4.5bn in 2016
- Yields fell by 0.75% for the average scheme, increasing liabilities by 16%
- Schemes’ asset returns of 8% to 10% were not sufficient to match liability increases
- Schemes that have been able to de-risk over the period have been somewhat immunised
Falling yields on corporate bonds drove up the pension deficits of Irish schemes in 2016, with defined benefit deficits for the ISEQ constituents estimated to have increased 50% from €3bn to €4.5bn in the period, according to data compiled by Mercer. Discount rates, used by companies to value their pension schemes which are based on corporate bond yields, fell by approximately 0.75% for the average scheme, increasing liabilities by 16%. This increase has not been matched by returns on schemes’ assets, which have generally ranged between 8% and 10%.
Peter Gray, Risk Financing Specialist at Mercer, commented, “2016 has seen the overall deficit at Irish listed companies increase by 50% due to the fall in corporate bond yields. Up until recently, low yields have been offset by lower inflation expectations. However, the end of 2016 saw inflation expectations rise, inflating liability valuations. Scheme assets have performed well over 2016 but have fallen short of the increase in liabilities, resulting in higher deficits.”
Corporate bond yields fell rapidly over the first nine months of 2016 reducing discount rates. Although they increased somewhat in the final quarter, year-end discount rates were still at their lowest level ever. Schemes that have been able to de-risk, for example by investing in matching assets, have been somewhat immunised against these falls but many others cannot afford to lock in low yields and have suffered as a result.
The recent rise in inflation expectations could provide a chink of light for 2017 and beyond. Signs that inflation is expected to return may encourage the European Central Bank (ECB) to end or reduce its bond buying programme, which is designed to stimulate inflation within the Eurozone. Yields could rise generally across the Eurozone as the ECB’s intervention in the bond market, a likely contributor to current low yields, wanes.
“Sponsors and trustees alike face challenging market conditions which can make it difficult for schemes to de-risk. However, market conditions could change rapidly and opportunities to protect schemes against future volatility could occur. It is important that trustees and sponsors are in a position to capture these opportunities to achieve funding level improvements,” 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 maintaining higher allocations to growth assets.”
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.
Mercer is a global consulting leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and careers of their most vital asset – their people. Mercer’s more than 20,000 employees are based in 43 countries and the firm operates in over 140 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global professional services firm offering clients advice and solutions in the areas of risk, strategy and people. With annual revenue of $13 billion and 60,000 colleagues worldwide, Marsh & McLennan Companies is also the parent company of Marsh, a leader in insurance broking and risk management; Guy Carpenter, a leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a leader in management consulting. For more information, visit www.mercer.ie. Follow Mercer on Twitter @MercerIreland.