Hedged Aviva schemes survive rate cut

The news comes as the Bank of England’s Monetary Policy Committee cut the base rate to a historic low of 25 basis points, and introduced a fresh round of quantitative easing measures which could drive gilt yields into negative territory.

But where falling yields have pushed liabilities and deficits higher for many schemes in recent months, the net surplus across Aviva’s staff schemes increased to £2.7bn from £1.6bn in June 2015 on an IAS 19 basis.

In its half-year results published last week, the company said: “The surplus has increased over the period largely as a result of increased asset values, mainly driven by a reduction in interest rates in the UK.”

The results also show a marked increase in the pension schemes' inflation-linked bond holdings of £5.4bn, to more than £11bn since December 2015.

A spokesperson said: “The schemes aim to mitigate interest rate and inflation risk through a combination of bonds and swaps, and index-linked bonds are used in that context.”

Mark Wilson, chief executive at Aviva, maintained that the effects of falling interest rates would not be felt equally across the industry.

“That’s like saying that all race cars perform the same in wet weather,” he said.

A painful cut

Bob Scott, senior partner at consultancy LCP, explained that the schemes’ large accounting surplus might not reflect funding on an actuarial basis.

“Even though they might have a surplus for company accounting purposes, it’s quite possible that they might have a deficit or a lower surplus for funding purposes,” he said.

Scott said the Bank of England’s decision to cut rates and expand quantitative easing was “not good news” for UK pension funds as a whole, as falling yields would push liabilities and deficits higher, despite increases in the market values of assets in the days after the announcement.

He said government and the Pensions Regulator would be aware of the potential for the increase in deficits to lead to more schemes falling into the Pension Protection Fund, and urged them to consider legislative change.

“There will be some schemes that inevitably go into the PPF, and this may have just hastened the process. But there are some easements which the government could introduce that might help some schemes, and one that has been floated quite a lot and talked about is to ease the requirement to provide indexation in line with [the retail price index],” he said.

Schemes are only statutorily obliged to provide indexation in line with the consumer price index since 2011, but the particular wording of scheme rules can prevent some from adopting this change.

Still time for LDI?

The amount of damage done to scheme funding levels by last week’s decision will depend largely on the amount of hedging undertaken by individual funds, according to Richard Dowell, head of clients at fiduciary manager and consultancy Cardano.

“Although a lot of schemes have embarked on [liability-driven investment], not every scheme is fully hedged, and therefore they still would have seen some pain in their funding position,” he said.

“The important thing is that they have actually protected their position to a large degree,” he added. “I think they’ll be thankful they’ve done it.”

He warned trustees who have not yet embraced LDI against relying on interest rates going up, explaining that the negative yields seen in Japan and Europe could easily occur in the UK.

“One question is, 'Can you as a trustee afford to take the additional pain if interest rates were to fall even further due to concerns about growth, concerns about the economy?'”