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Irish pension liabilities soar as interest rates fall

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Growth in Irish pension scheme assets over the past year has been heavily outstripped by soaring liabilities because of falling interest rates, according to a survey.

Mercer’s Pensions Risk Survey found that, while fund values went up by an average 18% during 2014, liabilities increased by more than double this amount over the same period.

Sean O’Donovan, head of defined benefit (DB) risk at Mercer, said: “The year started with a lot of promise. Most pension plans saw an improvement in their funding position primarily due to stock market rises.

“However, continuing falls in interest rates resulted in corporate bond yields hitting an all-time low, and, in turn, the pressure on pension scheme liabilities increased significantly.”

In 2013, deficits increased by €1.8bn.

But Mercer’s analysis shows the accounting deficit of Irish DB pension schemes increased from €5.4bn at the beginning of 2014 to an estimated €10bn at the end of 2014.

The survey covers pension schemes for leading semi-state companies, and companies listed on the Irish Stock Exchange.

Both global equities and fixed interest bonds performed strongly over the year, but this was partially offset by the euro weakening against other major currencies.

The rise in bond values was a result of falling interest rates, leading to substantially increased balance sheet liabilities.

O’Donovan added: “History has shown us a strategy should be established in advance to allow decisive and nimble action if and when favourable conditions return, rather than leave it to intuition or chance.

“In the meantime, stakeholders are looking at alternative methods of reducing the overall level of risk, such as derivative hedging strategies and by considering liability risk management tools.”

Jerry Moriarty, chief executive of the Irish Association of Pension Funds (IAPF), said falling interest rates were of great concern to IAPF members.

He said: “While schemes are doing all they can to work towards recovery, this has the potential to put a lot of recovery plans off track.

“The worry is that, in putting the funding plan together, schemes have already reduced benefits and increased contributions, so there may not be much more room for manoeuvre.”

Moriarty said the impact of lower interest rates would not be apparent until schemes had completed their end-of-year funding calculations, but it was clear their liabilities would increase significantly.

He said: “These are changes trustees have no control over, so we would like pension funds to have scope for flexibility in dealing with this situation, and we will be asking the regulator to allow this.”

Michael Butler, LCP Ireland’s head of investment consulting, agreed this was a problem, as bond yields in the euro-zone were at all-time lows.

He said: “The impact of these increasing deficits will [hit] company balance sheets and potentially their [ability] to borrow.

“In addition, with the ECB quantitative easing programme purchasing further euro-zone debt, it is likely that bond yields (government and corporate) will remain at depressed levels in the near term.”

Butler said that, with yields at such low levels, trustees of client pension funds were reluctant to increase their allocation to core euro-zone bonds at present.

But he said they understood the need to de-risk.

He said: “Trustees are generally reducing their allocation to equities as part of an agreed de-risking strategy, and instead investing in asset classes such as private sector credit, multi-asset funds and absolute return bond funds.

“Pooled LDI solutions are also gaining traction as a capital-efficient way of hedging interest rate exposure, while maintaining the potential for a higher return relative to physical government bonds.”

 

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