The Pensions Regulator’s (TPR's) announcement, in its first annual funding statement of 2012, that it will cut no slack for pension schemes suffering from the government’s quantitative easing (QE) programme has already hit the share prices of companies carrying large liabilities.
The National Association of Pension Funds estimates that the government’s £325bn QE programme, which has reduced gilt yields to record lows, has increased pension liabilities by £270bn. TPR, however, has taken a firm stance, saying that a relaxation of the rules would not be “a prudent approach as it seeks to second guess future market conditions”. It has agreed, however, to give greater breathing space, offering a degree of flexibility around the ten-year deadline for ending shortfalls in schemes for 15% of the UK’s 7,000 final salary scheme sponsors.
Critics say TPR's stance that a break from the "real market" would be a slippery slope is unrealistic and that gilt rates are unlikely to remain at their current record low levels for the lifetime of current pension liabilities.
BT Group shares have fallen from 216.5p to 212.3p in the two days following the announcement, while Royal Dutch Shell’s shares have fallen from 2274p to 2241p.
TPR's decision is particularly pertinent because the International Accounting Standard Board’s new accounting standard, IAS19, comes into force next year and will have a huge impact on the profits of companies running final salary schemes. The biggest change is the removal of the “expected return on assets” in schemes, so instead of crediting the expected return of assets to the profit account, the figures will be calculated using the discount rate with reference to the yield on AA-rated corporate bonds. As this is typically lower, FTSE 100 company profits could be reduced by around £3bn, according to Lane Clark & Peacock.
Simon Jagger at Jagger & Associates also points out the practical difficulty that the pool of long dated (over 15 year) AA bonds is small, totalling £26bn or just 1.8% of the UK bond market. “There are only 59 bonds involved, and of these only 32 have UK issuers,” he says. “So, a set of properly matched portfolios is impossible for pension schemes unless done through derivatives (with associated counterparty risk). Moreover, small moves in the yields on those bonds can have a disproportionate effect on liability valuations.”
Author: Ceri JonesCeri Jones has been writing about pensions for 25 years, first editing Pensions & Employee Benefits magazine and subsequently the FT's Pensions Management magazine in the mid-1980s.