On the go: The defined benefit liabilities of the UK's largest companies shot up by £30bn at the end of August, according to Mercer, as a slump in corporate bond yields refocuses trustee minds on immunising risk.
The aggregate deficit of the FTSE 350 ended the month at £67bn, a jump of £16bn and the largest increase of the year so far.
A fall of 0.3 per cent in corporate bond yields was to blame for the movement, lowering the discount rate used by companies when estimating a deficit for accounting purposes. Actuarial valuations, which determine the level of contributions to be paid into a scheme, are more closely linked to gilt yields, although these have suffered similar falls.
The liability increase was partially offset by an overall rise in asset values to £847bn from £833bn. Mercer said schemes that had not implemented a hedging programme against falling interest rates bore the brunt of the pain.
Charles Cowling, an actuary at Mercer, said the Brexit drama engulfing Westminster and the increasing chance of leaving the EU without a deal could create further headwinds in financial markets.
“Facing a potential sterling crisis and a spike in inflation, trustees and sponsors would be wise to prepare for political volatility and very difficult financial markets. Combined with downward pressure on interest rates, as President Trump increases pressure on the Federal Reserve to cut rates far more aggressively, the months ahead could see serious implications on scheme finances and risk," he said.
“Trustees will also be looking nervously at to see how employer covenants are affected by a no-deal Brexit. Against a very uncertain backdrop, trustees will have real challenges in making effective decisions,” he continued.
“It’s important that they examine the risks they are taking and work through various scenarios to establish whether their schemes face material dangers. In particular, trustees should look at the investment risks they are running. Many schemes should consider putting in place pragmatic mitigating measures and investment de-risking at the earliest opportunity.”
If financial conditions are impressing the importance of prudence on trustees, analysis by Aon of funding negotiations completed in the year to July suggests many schemes are already funding toward the new long-term funding targets encouraged by the Pensions Regulator.
Sixty per cent of schemes used a long-term target, in addition to technical provisions, to set their level of employer contributions. Of those, 80 per cent are targeting buyout and 20 per cent self-sufficiency.
However, just 18 per cent are using the cost of buyout as a discount rate. A ‘gilts flat’ approach proved the most popular, with 28 per cent of schemes using this.
