FTSE 350 companies’ ability to support their defined benefit (DB) obligations has fallen for the first time in more than three years, driven by a sharp decline in inflationary expectations, and continued wrangling over Europe’s finances affecting gilt yields.
PwC’s Pension Support Index shows a 3 point decrease since 2014 to 80 out of a possible score of 100, despite a period of improving company performance. The index tracks the ability of FTSE350 companies with DB pension schemes to meet their collective pension obligations, indicating the overall level of employer support available.
Continued uncertainty over gilt yields, often used to value pension liabilities, led to the first decline in the index since September 2011 and raises questions over pension scheme investment strategy.
The question of support for pension obligations has become increasingly important in light of changing market conditions. Ballooning deficits may lead to higher demand for cash from pension scheme trustees, which could lead to increasing demand for alternative non-cash funding mechanisms, such as Asset Backed Contributions (“ABCs”).
In this short video, Jonathon Land, Jeremy May and Simon De Young discuss the reasons behind the drop in the PSI score and what pensions companies and trustees should do about it, how ABCs can help, as well as the outlook for gilt yields.
Welcome to the latest issue of the Pension Support Index which tracks the ability of the FTSE350 to support their pension promise.
I’m Jonathan Land and I lead out Pension Credit Advisory Team.
There have been some really unusual movements in the Index this year and I’ve asked Jeremy May from our Actuarial Team and Sam D Young, from our Asset Backed Contribution Team to join me to discuss some of these movements.
The Index has been moving steadily upwards since 2011 as the economic recovery fed in to improve company performance. However, this was brought to an abrupt halt in September 2014 when a fall in gilt yields led to a sharp increase in deficits and a corresponding fall in the value of the Index. The increase in deficits and fall in Index has brought the issues of legacy DB obligations firmly back on to the agenda.
Should companies now put more money in to pension schemes? Should Trustees be worried and what should they do about it?
So Jeremy, let’s start with falling gilt yields. What’s happened here, why have gilt yields gone down?
So Jonathan it’s worth remembering that what we’ve actually seen since about September of last year, is a fall through until about January of this year. Since January we’ve actually seen a sort of a stabilisation and actually a steady rise in gilt yields, but the fall predominantly was driven by the fact that actually most market commentators were thinking that the key engines for growth in the world’s economy were actually stalling or had signs of stalling.
And what does this mean for pension schemes, why is this causing a problem for pension schemes?
So of course under most actuarial measures, the way that the discount rate is constructed essentially is heavily linked to gilt yields and therefore lower gilt yields means lower discount rate which means a higher value being placed on the liabilities.
And is this something companies and Trustees should react to? What should they do about this?
I think it’s a very good question and I would tend to split the audience, so to speak, in to three different buckets, there are those organisations and pension schemes who’ve got a long term view and that long term view doesn’t necessarily involve being invested in gilts or similar assets and therefore they actually might take a view that there’s no need to react to the current situation. There’s a middle bucket which are pension schemes and organisations who do have some longer term aspiration about matching or buying out their liabilities in the insurance market and therefore where gilt yields are is a real question for them and they have to really think very carefully about what the current position means and then there’s a third category of organisations who may not actually necessarily want to be tracking the fortunes of gilt yields but actually because of the underlying strength of the business which supports them, they are in a situation where actually too much downside could put the business in real jeopardy.
OK, so in a way it actually depends whereabouts on the Index you are as to what the strategy you might take.
That’s exactly right, and I do encourage organisations to think very carefully, Trustees and organisations think very carefully about what is their longer term strategy they’re trying to achieve here.
OK and Sam turning to you, do asset backed contributions create an opportunity here, is this something Trustees and companies can use to help in this situation?
Yes absolutely, and asset backed contributions or the disposal of an asset to the pension scheme to reduce what would otherwise be cash contributions to the scheme and it does it effectively through two mechanisms. One is, the pension scheme has security over the whole asset and can sell it if there’s a default situation and secondly the asset would normally produce and income stream e.g. rent, which would replace the otherwise recovery payments but would be paid over a longer period of time.
OK and we’ve seen asset backed contributions around for a while, what are the latest developments in this space?
Well, first of all I would say this fits all sizes of businesses now, we see transactions as small as £1m and as big as £1.7bn. I’d also add that this covers all assets, it’s not just about real estate, recovered stock, debtors, intercompany loans and other types of investments.
So it’s actually got more creative over time?
Much more creative and I think there’s two main points I’d make and one is; I think this is becoming more of a global opportunity, so actually we’re seeing international groups taking international assets and putting them in to their pension schemes and secondly; it’s much more dynamic, so whereas when I said it’s about reducing cash, it’s also being used for the overall pension strategy, either reducing risk or improving investment performance of the scheme.
OK, that’s really helpful and I suppose Jeremy just coming back to you to close, so over the next few years, what’s going to happen to rates?
That’s a very good question! The glib answer would be they’re going to be different to where they are now, different to where people expect them to be, but actually if I was to stick my neck out and I think the gilt yield curve will end up rising more quickly than it’s currently priced into the market.
Well, you heard it here first and time will tell and we’ll see what the next addition of the Pension Support Index after this one and what the answer is, thank you for listening.