30 June 2022
This document sets out the market practice on pensions accounting assumptions at 30 June 2022 that PwC has observed, key market indicators and current pensions accounting developments.
Both equity and bond prices fell over the quarter against the backdrop of concerns over high global inflation and the increased risk of recession, fuelled by the ongoing disruption to supply chains due to the war in Ukraine and rising interest rates (as well as the prospect of further tightening of monetary policy). Two sharp falls in the FTSE All-Share Total Return Index, in May and in June, led to it ultimately finishing the quarter around 5% down, albeit remaining up year-on-year by around 2%.
AA-rated corporate bond and gilt yields both increased substantially over the quarter, ending it around 1.10% p.a. and 0.85% p.a. higher respectively. This means that credit spreads have widened further, by around 0.25% p.a., reflecting the increased economic uncertainty and pessimism.
The large increases in bond yields have led to significant reductions in scheme liabilities and the emergence of greater surpluses, despite the equity falls (with many schemes having already substantially sold their equity portfolios). We estimate that UK's defined benefit pension schemes hit a record £250bn funding surplus at the end of June, with the "best estimate" accounting position even healthier, particularly given widening credit spreads.
Long-term inflation expectations also fell over the quarter by around 0.50% p.a., likely in response to the Bank of England's recent decision to increase the base rate (see below). Long-term inflation expectations are now broadly similar to a year ago.
UK inflation has reached new heights over the last quarter, with CPI inflation reaching 9.1% in May 2022 (a four-decade high), and RPI inflation at 13.7%, with both food and energy prices rising rapidly. Further increases are expected, with CPI inflation estimated to reach 11% in Q4 2022 and to remain well above the Bank of England's target of 2% p.a. for another two years.
Consequently, in an effort to control the rising inflation, the Bank of England increased the base rate twice, in May and June, from 0.75% p.a. to 1.25% p.a., with further rises expected later this year.
Companies should consider the impact of rising inflation on their investment strategy, including the level of hedging. Inflation-linked pension increases are often capped, meaning that the hedging required within pension schemes in such an environment is lower. Communication to members during times of volatile inflation can also be critical.
Finally, companies need to think about whether - and how - they capture the impact of the latest high inflation within their liability calculations for financial reporting purposes. Allowing for actual inflation annually is now standard practice and adjusting for the very latest published inflation figures is becoming increasingly common.
30 June 2022
30 June 2021
|Optimistic||Median||Prudent||Optimistic||Median||Prudent||(0.1% pa/1yr )|
|Discount rate||3.9% pa||3.8% pa||3.6% pa||2.0% pa
||1.9% pa||1.7% pa||c.£10m|
|RPI inflation||2.9% pa||3.2% pa||3.5% pa||2.9% pa
||3.2% pa||3.4% pa||c.£8m|
|CPI inflation||2.3% pa||2.6% pa||3.0% pa||2.3% pa
||2.6% pa||2.9% pa||c.£4m|
|Life expectancy (male @ 65)||20 years||22 years||23 years||20 years
||22 years||23 years||c.£15m|
|1. These ranges cover schemes of all commonly observed durations and do not represent PwC’s internal acceptable ranges.
2. The sensitivity figures shown represent a typical scheme with liabilities of £500m.
3. The RPI inflation assumption sensitivity allows for an equivalent movement in the CPI inflation assumption.
4. The ranges of CPI inflation assumptions quoted reflect an average of pre- and post-2030 rates for a range of different schemes that we have observed in the market at the relevant date.
5. Life expectancies are specific to each scheme’s population and should generally be set based on scheme-specific factors and analysis.
|Key market indicators||30 June 2022
||31 March 2022||Change
||30 June 2021
|FTSE All-Share Total Return Index||7,981.32||8,404.67||DOWN 5.0%||7,852.35
|UK fixed interest gilt index||4,633.38||5,402.07||DOWN 14.2%||6,006.37
|iBoxx AA corporate bond index yield||3.82% pa||2.73% pa||UP 1.09% pa||1.86% pa
||UP 1.96% pa|
|RPI inflation (20-year spot rate)||3.60% pa||4.07% pa||DOWN 0.47% pa||3.58% pa||UP 0.02% pa|