With gilts hitting all-time lows, the argument over DB scheme funding has resurfaced louder than ever. Sebastian Cheek gauges industry opinion.
“If you know your portfolio’s cashflows with certainty you would know you can pay those pensions, so why would you discount at gilts if the assets you are going to back them [with] has a higher yield? It is very logical thinking.”David Curtis, Goldman Sachs Asset Management
Once upon a time, index-linked gilts were considered a low-risk asset, perfect for hedging pension scheme liabilities. Having the UK government as a guarantor meant gilts were the go-to safe haven of choice for pension schemes and insurance companies looking to back their long-dated liabilities in line with inflation.
However, that fairy-tale world has been left behind. Today, UK gilts along with high quality corporate bond yields are hovering around their lowest ever levels which is bad news for the majority of pension schemes using them to measure their liabilities.
The downward trajectory in yields has been a theme for a long time, but the UK’s aggregate scheme deficit hit its worst point in late summer after the Bank of England slashed interest rates to 0.25% and increased its quantitative easing (QE) programme, moves which caused the 10-year gilt to plummet to 0.644%.
Yields have bounced back more recently, but with liabilities hitting record highs the debate over whether or not to use the mark-to- market return from UK government debt or high quality corporate bonds to calculate liabilities has been reignited more vociferously than before. The naysayers are looking at using a discount rate based on the projected return of assets in the portfolio, while others believe there is another way to address the problem altogether.
A BIG PROBLEM
The ‘problem’ is indeed a big one. According to the Pension Protection Fund (PPF), the aggregate deficit for the UK’s 5,954 defined benefit (DB) schemes increased from £376.8bn at the end of July to £459.4bn at the end of August – a funding ratio drop from 79.2% to 76.1%.