Discount rate drop to push pension fund liabilities through the roof

The industry standard index of AA-rated bonds yields, which are used by UK pension funds to calculate the discount rate, averaged at 4.1 per cent a year for the 15-20 year as of September 30 2012 and down from between 5.2 per cent and 5.4 per cent at September 30 2011.

A report by senior consultant at Punter Southall, Louisa Furniss, shows that lower AA bond yields will have striking consequences for scheme valuations in September and December.

Furniss said: “Discount rates have continued to fall over 2012, and while inflation has also fallen to an extent, companies are likely to be reporting higher liabilities on their balance sheets.”

The use of discount rates around 1 per cent lower than last year could lead to valuations showing higher scheme deficits as liabilities for funds around the 15-20 year scheme duration average come in at 20 per cent up or more. This is adjusted for a compounded 1 per cent drop for each year.

“This will be particularly true for pension schemes with low levels of inflation-linked liabilities and a high proportion of benefits that are fixed in nature,” Furniss continued.

“In addition, the added uncertainty surrounding the retail prices index given the Office for National Statistics’ recent consultation may mean that many companies will find it even more difficult to plan for reporting at the year-end.

“Combined with the forthcoming changes to IAS19 from 2013, overall companies are likely to start experiencing higher pension costs than in previous years,” she said.

Asset growth for the year-to-date September 2012 will also be substantially up for schemes with close to standard asset allocation as they price in the stock market low of September 2011, but will not keep pace with the liability rise.

Asset growth for December 2012 is very unlikely to follow in the same pattern as the FTSE 100 closed at 5572 on December 30 2011, recovering significantly on the September 2011 low.