Pensions In Ireland: Needing a break
Irish DB pension schemes remain under considerable pressure. While the global recovery in equity markets has provided respite, the fall in euro bond yields during 2014 will increase liabilities. Mooted European Central Bank bond purchases would put further upward pressure on liabilities. Having seen many difficult benefit reductions and funding plans implemented over the last two years, it would seem that Irish DB pension schemes cannot catch a break.
LCP’s latest survey into the funding of large Irish DB pension schemes reports that deficits decreased over 2013 as a result of euro corporate bond yields and increasing market performance. However, we estimate that a fall in these bond yields since December 2013 has resulted in a doubling of DB scheme deficits during 2014.
Our survey of DB schemes covered 16 of the largest companies (by market capitalisation) listed on the Irish Stock Exchange and other exchanges that have DB pension arrangements in Ireland. We also covered 13 semi-state/state-controlled companies with DB pension schemes that have published pension accounting information for the 2013 financial year.
The accounting standards look at the value of pension scheme assets and liabilities at the accounting date. Of the 29 companies analysed, only one reported that it had sufficient assets to meet its accounting liabilities (figure 1).
The average funding level for the schemes rose from 81% in 2012 to 85% in 2013.
This improvement was due to the strong rise in scheme assets (mainly equities) in 2013. While the yields on the majority of high quality corporate bonds (used to place a value on the accounting liabilities) rose over the year, this does not appear to have been reflected in the discount rates chosen.
The average discount rate for the companies analysed fell slightly from 3.9% to 3.8%.
World equity markets continued to perform strongly in 2014. However, high quality corporate bond yields have fallen significantly, down about 1.2 percentage points in the period to September 2014. This means that IAS19 liability values have increased since the end of 2013 as pension scheme liabilities are calculated by reference to these yields for accounting purposes.
Pension liabilities are generally very long-term in nature. As a result, small movements in discount rates can have a significant impact on liabilities.
A fall in the discount rate in accordance with observed bond yield movements over 2014 will have a dramatic impact on the value of pension liabilities. Indeed, the balance sheet impact may lead to further pressure on trustees to amend benefits despite the measures taken in recent years.
LCP estimates that the aggregate pension deficit for the schemes analysed increased from €4bn in December 2013 to €8.5bn at 31 August 2014 (figure 2).
Figure 3 shows the size of accounting liabilities relative to market capitalisations. The total pension liability expressed as a proportion of market capitalisation fell over the year from 30% in 2012 to 24% in 2013. This is a reflection of the overall strong performance of the Irish Stock Exchange in 2013, up 34% year-on-year.
The companies analysed paid substantial contributions, over €1.67bn, to their pension schemes in 2013. While this is a reduction from 2012, it is clear that pension schemes remain a significant balance sheet cost for companies.
In many cases, employer contributions were significantly higher than the cost of accrual as attempts continue to eliminate past deficits.
This year, company accounts show evidence of having reduced member benefits. The reductions varied from pensionable pay freezes, changes in retirement age, reductions in pension increases to closure to future accrual. Indeed
the liability management exercises of some companies incorporated more than one element. At the extreme end, the DB pension scheme of a state-controlled bank was wound up.
Whereas previously one might have expected larger companies would have been able to ride out the ‘pensions storm’, it is now clear that neither size nor, indeed, state ownership offers protection from benefit reductions or windup.
The average equity asset allocation remained at 50% compared with last year, although this needs to be viewed in the context of the strong performance of the asset class (figure 4).
There was a slight move out of bonds (from 35% to 33%) into ‘other’ assets. This is likely to reflect the reluctance of trustees to increase their bond allocations while yields remain low. Should yields revert to historically ‘normal’ levels. it is possible we could see a stepped increase in bond allocations.
The overall proportion of assets in equities (50%) remains high when compared with other jurisdictions. For example, UK DB pension schemes operated by FTSE 100 companies hold on average just 33% of their assets in equities.
The discount rate is the key assumption used to value pension liabilities. Under IAS19 and FRS17, this assumption is based on the yields available on long-dated high quality (typically AA-rated) corporate bonds in the currency of the liability at the valuation date. The yields on high quality corporate bonds, and hence discount rates, will fluctuate from day to day in line with market conditions.
Figure 5 shows the discount rates used by the companies reporting with December 2013 year-ends. The majority of companies analysed disclosed a discount rate in the range 3.5-4.5% per annum.
In 2013, companies reported their results for the first time under a revised version of the international pensions accounting standard IAS19. The replacement of the ‘expected return on assets’ element of pension cost has resulted in a higher P&L charge for many.
The revised accounting standard has resulted in additional disclosure of items such as the sensitivity of the pension figures to different assumptions and financial conditions; and the average term, or duration, of the liabilities. These are important improvements, given that changes in financial conditions can lead to significant changes in the pensions figures disclosed.
In general, the new accounting standard has increased the level of detail disclosed in relation to investment strategies. This is a welcome improvement in light of the sophisticated strategies now in place for many pension schemes.
Mick O’Byrne is an actuary at LCP Ireland. The 2014 LCP Ireland Pensions Accounting Briefing is available at www.lcpireland.com