Reduced risk advised as pension deficits fall 35%

Pension fund managers should be looking to derisk their portfolios while interest rates offer what may be a temporary respite from increasing deficits.

Climbing yields over the past three months have led to a 35% improvement in Irish defined benefit pension scheme deficits.

Deficits declined in the opening half of the year by 35% from about €10bn to €6.5bn at the end of June with a noticeable improvement in the second quarter in particular.

“Despite the economic uncertainties in the eurozone, pension scheme deficits improved over the last six months” said Mercer head of defined benefit risk Sean O’Donovan. “A key driver for this was the increase in yields on corporate bonds which drives the calculation of liabilities.

“Most of the increase in bond yields took place earlier in June. More recently, the escalation of the Greek debt crisis towards the end of June had limited impact on bond yields.”

The improvement relates to valued attached to pension plan liabilities on company balance sheets which are determined by yields on corporate bonds. Interest rates are typically 0.4% higher now than at the start of the year which has led to a decrease in liabilities.

The improvement comes following a period of falling interest rates caused by the ECB’s quantitative easing project which involved large- scale buying of bonds and had a knock-on impact on yields.

The fluctuations seen over the past six months highlight the inherent volatility of company accounting positions and their sensitivity to interest rates.

“Even though defined benefit pension deficits have reduced there is continued uncertainty around the Greek debt crisis and the very significant equity market ‘correction’ in China,” Mr O’Donovan said.

“The ability to execute a robust risk and financing management plan quickly remains of prime importance.”

Annuities, which are linked to the price of government bonds as opposed to their corporate counterparts, have also become a cheaper as yields have risen slightly but the picture is “not as rosy” as that of corporate bonds, he added.