Pension Funding Levels Plunge in January 2016

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The first 2016 update of the PPF index (of UK defined benefit pension funds) is just out, and it wasn’t pretty

Falling long-dated interest rates over the month (the 30 year gilt rate fell by 0.3% to 2.3%) caused the present value of the liabilities to increase by some 6%, while the assets were virtually unchanged (presumably some positive returns from bonds being offset by negative returns from equities).

Overall this caused a fall in the aggregate funding level of 4.4%. This reverses the gains made in the 4th quarter of 2015. Only twice in the 10-year history has the funding level been lower – in January last year and in May of 2012 when the funding level fell below 80%.

Worth noting is that the funding ratio tracked here is in respect of the PPF-liabilities, which are usually less than the standard contractual liabilities of the scheme. Typically the self-sufficiency liability valuations that scheme trustees might use would be 25% higher.

The total deficit increased by nearly 80bn to the second-highest on record at 304bn.

I estimate that this increase in deficit would add roughly 0.4-0.5% p.a. to the returns required every year to become fully funded over the next 15 or 20 years (which might not sound like a lot, but given the difficulty and risk associated with achieving the already high returns many schemes need this can be quite challenging). Put another way, this extends the time to full funding for a scheme which resembles this average position by around 3 years.

The variation in the overall funding position remains driven by the liabilities, which have had a volatility nearly three times that of the assets over the life of the data series, pointing toward LDI strategies as the first port-of-call for pension schemes trying to stabilize their funding position.

In a paper written last year I commented on the asset allocation changes in UK pension schemes. There has been some adoption of LDI strategies, but much de-risking has consisted of removing return seeking assets without fully hedging LDI risks, which leaves schemes vulnerable to interest rates falling a we have seen this month.

PPF Jan 2016


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