It is well known that pension scheme valuations are not an exact science.
Often the best you can hope for is that the valuation will give you a broad indication of the health and wealth of the assets in the fund, the extent and duration of the liabilities, the gap between the assets and the liabilities — either positive or negative; in surplus or in deficit — and the measures that are deemed necessary to meet any shortfall.
There are different kinds of valuations, for different purposes. Actuarial valuations are the ones that matter most to members and beneficiaries, as these are the ones that count — that result in the amount of retirement income that you will eventually receive being higher or lower. Accounting valuations are the ones that matter to finance directors and stock market analysts, as they are the ones that indicate to investors what a company might need to do to meet the various regulatory requirements and to present a “nice” image to the market.
We all know that stock markets can be volatile. Stock prices can change thousands of times during a trading day, but buyers and sellers know what price they get and what the reward and damage will be. With accounting valuations you know what the “snapshot” values are for the assets and the liabilities, but you won’t know what that means for your pension or for the prospect of your sponsoring employer being able to meet the pension promise.
Ideally, the assets should be greater than the liabilities, but these days that is unlikely. As an example, recent figures from Mercer’s monthly Pensions Risk Survey show the extent of the aggregate accounting deficit for the defined benefit pension schemes of the United Kingdom’s 350 largest listed companies. This increased from £81 billion ($126 billion) at the end of June to £95 billion ($148 billion) at the end of July, a rise in the month of 17 percent; a deterioration that was largely due to a relatively small reduction in corporate bond yields.
Ali Tayyebi, senior partner in Mercer’s retirement business, comments that a relatively small reduction in yields available on long-dated corporate bonds means that the deficit increased quite substantially over the month:
“It is particularly concerning that deficits have now edged very close to the last monthly high, as seen at the end of January 2015, despite corporate bond yields being nearly 65 basis points higher than they were at that time.”
Asset values in the Mercer survey at the end of July were £633 billion ($987 billion) and liability values were £728 billion ($1.13 trillion), so the shortfall was the stated £95 billion — or 13 percent; Mercer estimates that its survey data relates to half of all U.K. pension scheme liabilities. To emphasize how volatile funded status levels can be and how quickly the story can change from one month to the next, one month earlier Mercer’s survey had reported an improvement in funded status (to a deficit of £81 billion at the end of June, from £93 billion one month earlier) and a 4 percent reduction in liabilities. It’s a yo-yo ride; up one month, down the next.
Le Roy van Zyl, principal in Mercer’s Financial Strategy Group, adds:
“Despite the threat of a potential Grexit, the ongoing market issues really relate to the unfolding economic situation in China and the timing of the US monetary tightening. For pension schemes, being prepared for both optimistic and pessimistic market scenarios remains key.”
For an industry that is meant to pride itself on its long-term approach to investment, though, this rollercoaster performance and the monthly reminders of the continuing fragility and volatility of pension schemes’ funded status must be unwelcome. Pension scheme valuations may be an inexact science, but, like engineers, scientists are meant to be able to work out what is wrong and fix it. A good engineer will tell you how much it will cost to fix the problem, but somebody has to find the money.
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Richard Fleming is editor of The Institutional Real Estate Letter – Europe.
