More than 40% of schemes will undergo a triennial actuarial valuation this year. Owen Walker assesses their main obstacles – and how to overcome them
Pension schemes undertaking an actuarial valuation this year face a culmination of global economic factors that could leave their funding position artificially low.
Schemes undergoing a valuation
The majority of schemes undergoing an actuarial valuation this year will base it on a date in the next two months, information from schemeXpert.com’s sister title MandateWire has shown.
Here is a selection of schemes going through the process:
Scheme A: This £360m fund with a charity sponsor is due to complete an actuarial valuation as at March 31.
Its 2009 valuation showed a deficit of £102m but the scheme manager put this down to it taking place “when asset prices reflected a low point in investment markets”.
An estimate of the funding position as at March 31 2011, showed a deficit of £50m.
Scheme B: This plan also has a charity sponsor and will undergo a triennial valuation this March.
The £75m scheme, which is currently 75% invested in equities and 25% invested in bonds, closed to new members in December.
The pension fund's manager and secretary said it would be using the results of the valuation to restructure its investment strategy.
Scheme C: This £86.5m closed final salary plan is due to conduct its next triennial valuation this September. It is the first valuation since it closed to future accrual and changed to a bond-based investment strategy.
The fund is 46% invested in corporate bonds and 44% invested in gilts, having been 70% invested in equities two years ago.
The scheme manager said buyout was still on the agenda but it was now a 10-year goal.
Factors such as quantitative easing, the eurozone crisis and tensions in the oil market have the potential to lead to some very tense conversations with scheme sponsors over ongoing funding requirements.
Schemes going through the process have been urged to take a common-sense approach to negotiations with employers and to try to separate scheme-specific and wider economic factors.
“The funding level is going to be the area of biggest discussion with sponsors,” said David Collinson, co-head of business origination at the Pension Insurance Corporation (PIC).
More than 40% of schemes will undergo a triennial valuation this year.
This is due to the high number of schemes that first went through the process in 1997 with the incoming minimum funding requirement legislation.
Impact on valuations
A slight fall in gilt yields can have a massive impact on the size of pension scheme deficits as these are used by actuaries as the basis for discounting liabilities.
PIC predicted that a 30 basis point drop in gilt yields as a result of the recent round of quantitative easing – combined with a eurozone crisis-induced 10% drop in equity markets and inflation remaining below 5% – would increase deficits by £85bn.
“Violent shocks to funding positions can appear pretty much out of the blue and it is essential trustees manage risk as effectively as possible,” said Collinson.
“There will unfortunately be many tough conversations about funding plans following March’s triennial valuations.”
Two schemes undergoing a valuation this year told schemeXpert.com’s sister title MandateWire they had differing strategies for derisking.
The pensions officer at a £49.5m scheme said it was periodically transferring 5% of assets from equities into bonds.
She said the scheme had completed a £30m buy-in deal last year and was looking at a pensioner buyout in the next two years.
But the secretary of a company with an £80m scheme said: “We were thinking of derisking the fund but because of the situation in the markets we decided not to do anything.”
Dealing with sponsors
There is a debate in the industry over whether the orthodox actuarial method of basing the discount rate on gilt yields is appropriate in the current environment.
Schemes need to take a common-sense approach and be prepared to compromise with the employer
“Many of our clients don’t believe it is fit for purpose,” said Jeremy Dell, partner at LCP.
“The method is a compromise between a financial method and an economic method, and it is unravelling in the current unusual circumstances.”
Dell advised schemes to approach discussions with their sponsor over the size of the liabilities by splitting out scheme-specific factors, such as longevity and investment return predictions, and economic factors such as gilt yields and inflation.
Schemes must also decide whether they believe the bond market will correct itself in the medium term or whether it has entered a "new normal".
“Schemes need to take a common-sense approach and accept there is something odd going on and be prepared to compromise with the employer that the headline deficit is not the whole story,” Dell added.
“However, the trustees’ biggest assumption could be that the current environment is not the new normal.”
