Consultant JLT Benefit Solutions believe gains made by schemes by switching indexation to Consumer Price Index (CPI) have been wiped out by falling interest rates.
Scheme sponsors and trustees are under false impression that switching to CPI has improved things, but the fall in long-maturity gilt yields have not been matched by the fall in corporate bond yields – used by companies to calculate liabilities in books, the consultant observed.
The pension liabilities in the UK have grown between 10% and 20% because of the fall in yields, JLT estimates.
“The spread between gilts and corporate bonds has increased. Pension liabilities shown in company accounts are measured by reference to AA corporate bond yields and so these will not show corresponding increases. In other words only half the impact will be revealed in company accounts and investors and others could well be in for a nasty surprise when the next funding valuation is prepared,” said JLT executive director Steven Robinson.
Compared to their typical yields of between 4% and 4.5% in recent years, UK government long-maturity fixed coupon gilts are currently returning 3.5% yields per annum, JLT observed.
“When the government announced the replacement of RPI by CPI, where scheme rules permitted, this was signalled as saving a scheme significant costs, so sponsors and trustees may have been under a false impression that things were getting better. Many of these gains will now have been wiped out by the impact of the fall in gilt yields,” explained Mr. Robinson.
The recent fall in equity values have landed another blow in addition to falling gilt yields to UK pension schemes, JLT said, adding this resulted in FTSE100 deficits doubling to £70 billion from £35 billion.
UK corporates may find re-risking measures such as capping pensionable salary, enhanced transfer value exercises and pension increase exchange exercises particularly attractive in the changed scenario, JLT said.