Accounting deficits for defined benefit (DB) pension schemes has only risen by £11 billion despite volatile markets, according to research by Mercer.
The consultancy’s Pensions risk survey showed that accounting deficits of £64bn at 30 September show relatively small increase from £53bn at 31 August.
Falling corporate bond yields, which are used to discount liabilities, and falls in the stock market would ordinarily result in an increase in the IAS19 deficit.
However, the value of pension scheme liabilities is also linked to market pricing of price inflation. Since the market’s view of longer-term price inflation has also reduced significantly over the period, this has largely offset the effect of the fall in stock markets and reduction in corporate bond yields.
In addition, a large proportion of most defined benefit schemes’ funds are invested in return-seeking assets. Changes in the value of these return-seeking assets often have a low correlation with changes in the value of the scheme’s liabilities.
This is because changes in the scheme’s assets and liabilities are influenced by different factors. The effect of this mismatch means timely monitoring of the changing market environment is important to capture market opportunities.
The IAS19 measure is typically the measure of defined benefit pension scheme liabilities used by companies when reporting their financial obligation to the scheme on their balance sheets. However, cash contribution requirements to the pension schemes are determined using different assumptions that, normally, are agreed between companies and pension scheme trustees. These alternative assumptions can be very different to the IAS19 basis.
Adrian Hartshorn, a partner in Mercer’s financial strategy group, said: “The events of the last month highlight the interplay of the various factors affecting the calculation of the deficit in pension schemes. In turn, companies and pension scheme trustees need to monitor their own funding position closely and stay close to emerging market trends to take advantage of changing market conditions”
Ali Tayyebi, senior partner and defined benefit risk group leader at Mercer, added: “To manage the effects defined benefit schemes can have on company balance sheets and on their bottom line, companies should consider collaborating with scheme trustees to develop risk management strategies that meet their objectives. In doing so, they need to be proportionate to the relative importance of the pension plan on the company’s financial and reporting position.”
For more on managing pension scheme deficits