How interest rate falls are affecting your pension scheme
At a glance
Long-term interest rates (gilt yields) have fallen 0.3% since the start of August and 0.9% over 2019 so far.
For schemes that aren’t fully hedged, this causes an increase in deficits. For an example scheme that is 90% funded and 80% hedged, the deficit will have increased in 2019 by over 50%.
Corporate bond yields have reduced too so balance sheets will see a similar impact.
Even if your scheme is fully hedged, large reductions in rates may cause unexpected gains or losses, particularly if the hedge is approximate.
If your funding valuation is in progress, your trustees are likely to raise the current deterioration in position. There are a number of approaches you can consider to ensure you aren’t committing to pay more cash than necessary.
Low interest rates also mean transfer values are at an all-time high, which may increase member interest in transfers.
You should check that transfers do not cause funding losses and the accounting impact is acceptable
Transfer values are at an all-time high
Since mid-2016 a transfer value for a typical member with a £10,000 pa pension has risen from £210,000 to £258,000, predominantly as a result of falling interest rates.
How have long-term gilt yields moved?
Actions employers can take
1. Check what impact low rates are having on your scheme’s funding position and talk to the trustees about whether action should be taken on your scheme’s hedging
2. If your funding valuation is in progress, consider contingent assets or contributions that are linked to the future funding level of your scheme
3. Review the impact that transfer values have on your scheme – do they improve or reduce your funding level?
4. Review member options exercises, importantly flexible retirement options, and ensure proper support is provided to members
What should you consider when agreeing funding in 2019?
Reduce the risk of future trapped surplus by paying funding into an escrow account. This can be set up to release contributions to the scheme only if the funding is required, i.e. the fall in rates is sustained.
Use these to support a longer recovery period and/or allow for future asset out-performance.
Agree that any payment of contributions into the scheme will be contingent on the scheme’s funding position at that point – to avoid paying in contributions unnecessarily
Prudence in long-term targets
Make sure any long-term funding target agreed is not too prudent – the Pensions Regulator is expecting to give more clarity in late 2019 on views on suitable long-term objectives
What might we expect from the Pensions Regulator
With higher deficits, it is important to understand what the Pensions Regulator may be thinking on future new rules. While quotes need to be viewed in context, a recent blog by the Pensions Regulator on its future expectations on funding gives some insight. For example:
For more information please see here