FTSE 100 deficits feel pain of corporate yield slump

Corporate defined benefit pensions took another blow this week as FTSE 100 schemes showed increased deficits of £5bn during the year to Dec 31 2014, according to consultancy Barnett Waddingham’s annual survey of the sector.

While unsurprising given the current low-yielding market environment, the increase in deficits will be disappointing for many companies who have made significant contributions to the pension scheme over the period.

Martin Hooper, associate at Barnett Waddingham and lead on the survey, said the key driver for widening deficits during the period was the “unprecedented” slump in corporate bond yields.

Source: Barnett Waddingham

Over the 12 months to December corporate bond yields fell to 3.6 per cent from 4.5 per cent, resulting in a corresponding 0.9 per cent decrease in average discount rates.

“They’ve come back up slightly since year end but it was a fairly rollercoaster ride up to March 31,” said Hooper.

Schemes with significant bond holdings have been protected to some extent while falling inflation has helped to mitigate the impact of falling discount rates

Martin Hooper, Barnett Waddingham

Assessing the damage, Hooper said the news was bad but could have been worse.

“Schemes with significant bond holdings have been protected to some extent while falling inflation has helped to mitigate the impact of falling discount rates,” he said.

Opposing views

Holding gilts and bonds, and running liability-driven investment strategies limited the damage for some schemes last year.

Simeon Willis, investment consultant at KPMG, said there were few practical limitations to schemes enhancing protections, but discussions on further hedging were often shut down by scheme stakeholders with strong market views. 

“The population with the strongest view that I’ve seen are [chief financial officers] and the treasury team within companies. That is feeding through very strongly into discussion between trustees and companies,” he said.

Willis said more balanced or ambivalent market views tend to be “shouted down” in discussion by those with high conviction that yields will rise more quickly than expected.

You don’t have to have a view that yields will fall further in order to hedge. The rationale for hedging is just this is an uncertainty you want to remove from the equation

Simeon Willis, KPMG

"The number of times I've heard people say 'yields can't go any lower surely, it would be ridiculous to hedge at these levels'. When they make these statements they feel that right is on their side," he said. “The balance of those two views tends to be to hold off hedging." 

Willis dismissed the need for a market view in considerations around hedging.

“You don’t have to have a view that yields will fall further in order to hedge. The rationale for hedging is just this is an uncertainty you want to remove from the equation,” he said.

Careful negotiation

Many employers will be aiming to reel in their deficits by increasing risk within the scheme’s investment strategy.

Matthew Harrison, managing director at covenant specialist Lincoln Pensions, said sponsors will generally prefer to take investment risk to recover the deficit position rather than putting cash into the scheme.

But Harrison urged sponsors to think carefully about the implications of increasing risk within the scheme.

“The extent to which [sponsors] take investment risk which is not hedged, you as the sponsor are the backstop and ultimately underwrite that risk,” he said.

Harrison said trustees are increasingly agreeing to extended deficit recovery plans and are therefore reliant on sponsor employers for much longer.

“Trustees must assess the ability of the employer to underwrite investment risk and take decisions based on that assessment,” he said.