Although asset have performed well over the past three years, low gilt yields mean that liabilities have still increased. Matt Scott looks at what DB trustees should do

A deflated gilt market is continuing to put a dent in the funding levels of UK pension schemes, despite an admirable performance from asset returns over the past three years.

Figures from JLT Employee Benefits show schemes had an aggregate funding level of 82% on an accounting basis at the end of March. After a turbulent spell, this is seven percentage points lower than in 2013.


But what does this mean for the roughly 1,800 schemes facing triennial valuations this year? Aon Hewitt partner and scheme actuary Lynda Whitney says she expects 2016 actuarial funding levels to remain at a similar level to three years ago.

“We thought that 2013 valuations were tough and that we weren’t in a great place, but since March 2013 asset performance has generally been quite strong,” she says. “But alongside that is gilt yields continuing to stay lower for longer and absolute levels lower by about 50 basis points.

“That means liabilities have increased as fast as asset returns have gone up. So what you are seeing is funding levels are, in aggregate, pretty flat despite the contributions that will have been made.”

Liabilities have increased as fast as asset returns have gone up”

PAN Trustees managing director and independent trustee Roger Mattingly says this stagnation, combined with the introduction of the Pension Regulator’s sustainable growth objective, means open dialogue with the employer is now more important than ever when it comes to funding negotiations and assessing the employer covenant.

“The new statutory objective has created the absolute need for a very collaborative relationship,” he says. “The trustees need to have empathy as far as the employer is concerned, and they need to understand why the company is spending money that could otherwise go into the scheme.

“But they also need to be minded to accept that rationale if it makes sense as far as the future sustainability of the company. If it doesn’t make sense then that is where trustees have to be more assertive.”

The trustees need to have empathy as far as the employer is concerned”

Trustees will also be able to draw on advice from the regulator in these negotiations when it publishes its annual funding statement towards the end of May.

Certainly, schemes that have invested in hedging strategies and diversification will have felt less of an impact from the falling gilt yields.

Deloitte UK head of trustee service Marian Elliott says: “Where trustees have adopted large levels of interest rate hedging, the impact of rate falls on the liabilities will have been offset to some extent by the increase in the asset value of interest rate hedges. Schemes that implemented significant hedging in late 2013 when gilt yields went up as high as 3.5% will have been protected against an increase in liabilities as a result of the subsequent fall in gilt yields.

“However, where schemes have maintained significant growth proportions in their portfolio and have limited hedging in place the funding position of these schemes has typically fallen markedly.”

Able Governance managing director and independent trustee Nick Boyes says that the cost of such hedging strategies can be off-putting for smaller schemes, but trustees need to be aware of the long-term benefits.

“These strategies can be effective, but getting the advice and the implementation can be quite expensive,” he says. “When you factor that into the funding of the scheme as a whole, it is still a relatively minor part.

“But trustees are often reluctant to spend money on advice that would encourage them to do this, as it is an upfront cost and can seem like it is just making the funding level worse – but it can actually lead to an improved position overall.”