UK - Pension funds are likely to continue to see significant pressure on their solvency levels over the coming months even though the arrival of new buyout firms has reduced annuity pricing pressures, consultancy Mercer has suggested.

A review of pension scheme funding through Mercer's Review Financial Management (RFM) database to June 30 2007 indicated prior to the reduction in bond yields and equity prices experienced over the last two weeks, pension fund deficits had fallen to just £9bn (€13.5bn) in three month from £35bn on March 31, and overall funding levels had improved from 93% to 98% to the end of the second quarter.

Improvements to funding levels were thanks to an earlier return on equities of 4.4% and in part because the arrival of new annuity buyout providers over the last 18 months has helped to drive down buyout deficit costs from around 140% of IAS19 liabilities to 125%, according to Mercer.

More specifically, this has had a "very beneficial impact on pricing by as much as 10% in some cases, according to Mercer.

This squeeze of provider margins has essentially reduced the buy-out deficit from £230bn to £120bn within the three months to June 30 and increased funding levels from 66% to 79% for FTSE 350 companies while the total pensions deficit for all private sector firms is now thought to be around £270bn.

That said, pension funds may find their liabilities will continue to be turbulent, according to John Hawkins, principal at Mercer, as there is still little hard evidence to suggest funds are using liability-driven investments and it will take some months for pension funds to recover from the latest short-term equity sector fall.

"We haven't actually re-run the numbers [since markets fell] but what has happened recently in the markets and the suggested impact on deficits will be a wake-up call for finance directors and chairmen of trustees who may have thought they would review risk but have not yet done so," said Hawkins.

"It will take a few months for equity markets to get back to those levels seen before. But we are not seeing a 1-in-20 year adverse event, more like once in five years.

"Those moving out of equities into bonds at an earlier stage could have been affected. And it's hard to known if companies are using [liability-driven investment [strategies]. The number of firms using [LDI] is still very limited. Companies still do not go to the level of detail to say whether they are adopting LDI. But we did do some earlier research with ACT suggesting the amount of derivatives usage by pension funds has increased, such as using inflation swaps to hedge funds," added Hawkins.