Rising interest rates have generated a €1 billion surplus for defined benefit (DB) pension schemes in Iseq-listed companies, according to an analysis by Mercer.
Iseq-listed companies will see improved funding positions relating to DB pension schemes in their year-end financial disclosures, with most schemes likely to be in surplus.
Despite all major asset classes ending the year in negative territory, with equity markets down 15-20 per cent, DB pension scheme funding positions have improved. A significant increase in bond yields has reduced the value of pension scheme liabilities, more than offsetting the fall in pension scheme assets.
Companies measure DB pension scheme liabilities with respect to corporate bond yields, which have risen by about 3 per cent over 2022, the largest 12-month rise in over 10 years. A rise in bond yields reduces pension scheme liabilities, with Iseq-listed companies seeing liabilities fall by 25-50 per cent in aggregate in 2022. The fall is despite recent high levels of inflation increasing pension scheme liabilities through rises in pensions in payment, and increases to former and current employees’ benefits through revaluation or salary increases.
Future inflation expectations increased by about 0.5 per cent over 2022, placing upward pressure on pension scheme liabilities, but these increases have generally been surpassed by the reduction in pension scheme liabilities due to the rise in bond yields.
Mercer estimates that the aggregate DB balance-sheet position for Iseq-listed companies could be a surplus of over €1 billion at the end of 2022. That compares with a small surplus at the beginning of the year and very significant multibillion-euro deficits at times over the last decade, peaking at a deficit of about €4.5 billion in December 2016.
Mercer corporate consulting leader Peter Gray said: “The improvement in pension scheme funding positions will be welcome news for companies, trustees and members alike. The rise in bond yields, triggered by the Central Bank’s efforts to control inflation, has seen a marked improvement in the financial position of DB pension schemes.
“The key questions are whether these higher yields will persist as inflation comes under control and how to take advantage of the current improved position – the corporate bond market remains volatile with yields down about 0.35 per cent over January.Some schemes have derisking frameworks already in place, which will have captured some of the gains from rising bond yields, but others will need to consider what to do next.
“This may involve increasing the amount of bonds and related assets they hold to better match expected cashflows and reduce future exposure to changes in bond yields. While transferring pension risk to an insurance company has traditionally been seen as too expensive, a combination of improved funding levels and a reduction in annuity pricing, again driven largely by the increase in bond yields, may present an opportunity for employers to explore annuity transactions with the scheme’s trustee board.”
Improved funding levels and recent high levels of inflation will likely see trustees and pensioner groups requesting the award of pension increases to current pensioners. The vast majority of pension schemes in Ireland do not automatically increase pensions in payment but some allow awards on a discretionary basis.
