Deficits in defined benefit (DB) pension schemes in ISEQ-listed companies reduced in the second quarter due to significant increases in global equity markets, according to analysis published by Mercer today. Overall, Mercer estimates that the cumulative DB balance sheet deficits for these companies reduced from €1.2bn at the end of Q1 to €1bn in aggregate at the end of Q2.
Equity markets rebounded by c.15% in Q2, improving pension scheme funding positions. However, despite the rally, equity markets are still below where they were at the beginning of the year. European stock markets are down over 10%, and while US stocks have performed better, they are still down c.5%. Somewhat surprisingly, the NASDAQ Composite Index is up c.10% year-to-date, but this index has a greater weighting of technology and internet related stocks, which have performed well.
The rebound in equities was enough to offset an increase in the value of liabilities. This was due to a reduction in corporate bond yields in the second quarter, as central banks responded to the global pandemic by implementing huge fiscal stimulus programs. Discount rates fell by c.30bps in Q2, but remained c.15bps higher than at the beginning of the year. Companies reference AA corporate bonds to measure DB pension scheme liabilities.
Inflation expectations also rose slightly which will have further increased scheme liabilities, but inflation expectations remain below where they were at the beginning of the year. Falling discount rates and increased inflation expectations will have increased pension scheme liabilities c.5% over Q2.
Peter Gray, Corporate Consulting Leader and Principal, Mercer, commented, “The second quarter of 2020 has generally been positive for pension scheme funding levels, with reported balance sheet pension deficits reducing. However, markets remain volatile as increased cases of COVID-19 cause concern for countries trying to contain the virus while keeping their economies afloat. Companies and trustees should consider potential downside risks and whether banking recent funding level improvements is appropriate.”
Pension fund trustees focus on their scheme’s ongoing funding level and satisfying the statutory solvency test, rather than the pension deficit on the company’s balance sheet. Increases in equity values and other growth markets will have improved general funding levels in Q2. However, as the full economic impact of the pandemic remains to be seen, trustees will be concerned about the ability of companies to fund schemes over the longer term.
Mr. Gray noted; “The Pensions Authority has recently announced that it will place an increased focus on governance and risk management in light of the expected implementation of the IORP II EU Pension Directive. It will undertake an assessment of the risks faced by DB pension schemes and the ability of the scheme trustees to assess and manage those risks. This will inevitably lead to conversations between employers and trustees regarding the long-term sustainability of schemes and the potential for alternative forms of security. This might include, such things as non-cash funding or contingent assets to provide greater investment flexibility and security to schemes while allowing cash preservation for sponsors.”
Members of defined contribution (DC) schemes will have benefited from the recent rise in equity markets as the majority of default investment strategies contain significant allocations to equities. The level of recent volatility demonstrates the difficulty in trying to predict the market, with those who rode out the volatility likely to have fared better than those who chose to sell out of equity markets, thereby missing the strong rally in Q2.
Pensions are generally considered long-term investment vehicles, with members who are many years from retirement being able to take a longer-term view when deciding on an investment allocation. Those closer to retirement will generally need to be more cautious in their investment outlook. Members are strongly encouraged to seek advice before making any decisions.
Notes for editors
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 that ISEQ listed 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 believes in building brighter futures by redefining the world of work, reshaping retirement and investment outcomes, and unlocking real health and well-being. Mercer’s more than 25,000 employees are based in 44 countries and the firm operates in over 130 countries. Mercer is a business of Marsh & McLennan (NYSE: MMC), the world’s leading professional services firm in the areas of risk, strategy and people, with 76,000 colleagues and annual revenue of $17 billion. Through its market-leading businesses including Marsh, Guy Carpenter and Oliver Wyman, Marsh & McLennan helps clients navigate an increasingly dynamic and complex environment. For more information, visit www.mercer.com. Follow Mercer on Twitter @Mercer.