Scheme accounting deficits increase over inflation fears

The combined accounting deficit on FTSE350 companies rose by £25bn in 2013 to £97bn, despite a 19 per cent return on equities and significant cash contributions from employers.

Pension scheme IAS deficits now stand 35 per cent higher than a year ago, although the funding ratio has only fallen from 88 to 85 per cent over the period, according to Mercer’s pensions risk survey.

But there was an improvement in the position over the last month of 2013, with the IAS19 deficit reducing from £102bn at 30 November. 

The data included in the Mercer analysis is based on publically disclosed accounting liabilities, and, as noted, shows that deficits on this measure have increased over 2013. But the funding measure, used by trustees and employers to determine the amount of contributions that need to be paid to schemes, and the solvency measure, used to determine the cost of insuring pension scheme liabilities with insurance companies, both showed declines in 2013.

Mercer says the increase in deficits is predominantly driven by the increase in long-term inflation expectations over the year.

Mercer head of DB risk, UK Ali Tayyebi says: “Over 2013 as a whole it has been interesting to see how the three key elements which drive the deficit calculation have independently influenced the deficit. Deficits increased sharply up to the end of April driven largely by increases in the market’s outlook for long-term market implied RPI inflation.  This was driven in part by the market reacting to the 10 January announcement by the ONS confirming that the RPI calculation would not be changed.  The position had recovered by mid-year as corporate bond yields increased sharply over Q2 reducing the value placed on pension scheme liabilities. 

“However, a further increase in long-term market-implied inflation and a reversal of some of the increase in corporate bonds yields increased deficits by £20bn over the second half of the year despite the UK stock market returning 10 per cent over that period.”

Mercer financial strategy group senior partner Adrian Hartshorn says: “As a result of the improved funding and solvency deficits, there has been an increase in activity to manage and settle liabilities. For example, 2013 saw a return to higher volumes of buyout transactions, the record having previously been set in 2008, and a record volume of longevity transactions completed, beating the previous record set in 2011.

“Looking forward into 2014, there are likely to be further transactions. These will likely involve a further transfer of risk to the insurance market through more buy out and longevity transactions. However, there are also likely to be other transactions and exercises implemented by scheme sponsors, such as options that allow pensioners and deferred pensioners additional flexibility in the way they draw their benefits.”