FCA scheme becomes latest to benefit from discount rate move

The discount rate is the investment return assumption used to calculate present value of scheme assets. In the past year, changes to the discount rate have contributed to reductions in deficits totalling hundreds of millions of pounds for both the Premier Foods and Sainsbury's schemes.

In the FCA’s annual report last week, it said an increase in the discount rate had led to a reduction in the IAS 19 deficit to £134.1m at March 31 2016, from £145.6m the year before.

Deciding to derisk in the future when you’re in a better situation is a bit like planning how you’ll spend your lottery winnings

Simeon Willis, KPMG

The discount rate, which shifted to 3.45 per cent from 3.4 per cent, also led to an actuarial loss of £6.5m, from £33.4m in 2015. The plan’s asset allocation remained relatively unchanged throughout the year, but both assets and liabilities improved.

Ben Roe, partner at consultancy Aon Hewitt, said increases in the discount rate were driven primarily by changes in the AA-rated corporate bond yield.

The movement of yields will have had a knock-on effect on the plan’s actuarial losses, he added.

“[Actuarial loss is] the difference between what’s actually happened to the deficit as opposed to [predictions],” he said. “So it’s really the change in the deficit that’s led to the change in that figure, which is itself driven by corporate bond yields.”

“Inflation expectations will also have had an impact,” he added.

Deficit contributions risk

The scheme made no major changes to its asset allocation during the year, but has dynamic derisking triggers in place to reduce its equity allocation in favour of corporate bonds and index-linked gilts when the funding position of the scheme increases.

The FCA’s recent annual report said: “These triggers have been determined to identify material improvements in the plan’s funding position, measured relative to its long-term funding target.”

The triggers are intended to “mitigate the risks of significantly increased future annual pension deficit funding contributions”.

Many schemes use triggers to set the levels at which they automatically make changes to their investments. Schemes using some types of trigger, for example based on gilt yields, have been forced to revise levels down in recent years as rates have remained stubbornly low.

Mark Ashworth, chair at professional trustee company Law Debenture, said: “A number of schemes have reduced target levels… they tend to be recalibrating using their existing levels. Those that were using interest rate levels or funding levels are still doing that but edging down.”

Ashworth added that rate-related triggers were the most common type used, ahead of the funding-based triggers used by the FCA plan and other types such as time-based. “If you have time-based you usually also have some combination,” he said.

Triggers ‘overused and oversold’

Triggers typically sell a higher-risk asset in favour of a lower risk one, such as selling equities in favour of bonds, or diversified growth funds in favour of liability-driven investment. Some schemes opt to sell into cash, but Ashworth warned against it.

“There’s a danger [when] moving into cash that the market moves against you,” he said. “Trustees are generally advised not to be clever with market timing.”

Simeon Willis, head of investment strategy at consultancy KPMG, said derisking triggers were “a little overused and oversold”, and that trustees should be careful not to think of them as a way of reducing risk in the present.

“People describe it as a risk management strategy. Deciding to derisk in the future when you’re in a better situation doesn’t do anything about the situation you’re in now. It’s a bit like planning how you’ll spend your lottery winnings.”