With long-dated gilts serving as a market indicator for the ‘risk-free’ rate of return for pension schemes, gilt yields are used by the vast majority of schemes to value current and future pension liabilities, meaning a fall in yields has led to the large increase in the value placed on pension scheme liabilities.
As such, Buck is calling for trustees and their advisers to consider the impact of falling gilt yields on their pension schemes and liabilities. For example, schemes without a robust hedging strategy in place, such as a liability-driven investment strategy, are likely to be facing significantly weaker funding positions due to the drop in yields at a time when many trustees are also facing increased liabilities from GMP equalisation and Brexit uncertainty.
In addition, pension schemes with contingent funding arrangements may need to determine if those arrangements have been triggered, whilst for others the volatile market movements may highlight the need to put a strong Integrated Risk Management framework in place.
Vishal Makkar, Head of Retirement Consulting at Buck in the UK comments: “With gilt yields dropping to a two-year low, we’ve seen a substantial impact on the value of funding liabilities of DB pension schemes across the UK, particularly in the last couple of months. No doubt, the recent market volatility will result in calls from some quarters for the pensions industry to re-evaluate the validity of the long used ‘gilts plus margin’ approach to setting discount rates and valuing pension liabilities. It will be interesting to see how this issue is addressed in the Regulator’s new funding code expected towards the end of this year.
However, the reality is most pension schemes set their valuation discount rate using gilt yields, so it’s vital for trustees and sponsors to respond quickly to these new market conditions.
“Of course, the best course of action will depend on each scheme’s unique funding position and investment strategy. Those schemes that have hedged their liabilities would have seen their assets increase to offset the impact of increasing liabilities. In other cases, trustees should be considering whether to implement their contingency plans as per The Pensions Regulator’s guidance. Where the sponsor covenant is particularly weak and the scheme has a high Value at Risk, trustees may even need to consider bringing forward their next actuarial valuation.”
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