ECB move provides ‘toxic cocktail’ for pension scheme funding
The impact on pension scheme funding as a result of the European Central Bank’s (ECB) quantitative easing (QE) needs to be managed and considered, consultants say.
Yesterday, Mario Draghi, ECB president, announced a €1.1trn programme to purchase euro-zone sovereign bonds in a bid to boost economic growth and stave off inflation.
However, as additional capital flows into sovereign bond markets across the currency union, historically low yields will be squeezed even further – affecting the discount rate used in pension fund liability accounting.
Research by Mercer in Ireland found deficits in defined benefit (DB) schemes for companies on the Irish Stock Exchange, and semi-state companies, increased by €10bn over 2014 as yields across Europe and the UK fell over the year.
“Yesterday’s announcement will further increase liabilities and, in many cases, deficits,” the consultancy said.
“The impact of QE, including falls in bond yields and the weakening of the euro, will cause further challenges for plan sponsors and trustees alike. Funding proposals, already facing pressure, may go off-track and need to be re-cast.”
Aon Hewitt global head of asset allocation, Tapan Datta, said the cocktail of ECB capital moving into bond markets – lowering yields and forcing funds to look elsewhere – was almost toxic.
“It could be worse if equity markets were weakened, but this has not happened,” he said.
“It would have completed the damage that has been done to funding levels.”
With funding levels, particularly in UK pension funds, now lower than they were five years previous, Datta said it gave credit to arguments for trustees to take liability risk management more seriously.
However, he said, on the other side, many of the developments have been unexpected, and nobody predicted oil prices would fall 60% and 10-year UK Gilts to still yield less than 1.5%.
“This is a rare market eventuality, which has caught a lot of people on the hop,” he added.
Mercer UK partner Alan Baker said there was no real impact currently, but that this was because QE had already been priced in by markets.
For UK pension funds, however, the outlook for funding was less rosy.
“There will now be a downward pressure on UK Gilts with a shift from investors in euro-zone bonds,” he said.
He said they would also be supported by a growing UK economy, which would also be boosted by economic growth for its euro-zone partners.
“It is not entirely clear which one is going to win,” he said.
“For European pension funds, the QE will not help them right now, as rates will be pushed down and stay down.
“But in the long-run it demonstrates the bank will to do something and stimulate the European economy, which will be a good for them.
“It is to some extent positive, but it is painful time now.”
In the Netherlands, Mercer and Aon Hewitt both warned of significant negative funding effects for pension funds as a result of the expansionary monetary policy.