Rising interest rates wipe out DB pension scheme deficits for ISEQ-listed companies 

• Mercer estimates that the aggregate defined benefit pension scheme balance-sheet position for ISEQ-listed companies could show a surplus of over €1bn at the end of December 2022.
• This surplus is largely driven by corporate bond yields, which increased by c. 3% over 2022, the largest 12-month rise in over 10 years.
• Increasing bond yields resulted in company balance-sheet liabilities decreasing by c. 25%–50%, more than offsetting the impact of the fall in equity markets and other growth assets over the year.
• For members of defined contribution pension schemes, 2022 was a challenging year with falling asset values and rising inflation; however, the cost of securing a pension by purchasing an annuity from an insurance company fell, offering respite for members choosing that option.

Dublin, 14 February 2023

ISEQ companies will see improved funding positions relating to defined benefit (DB) pension schemes in their year-end financial disclosures, with most schemes likely to be in surplus. Despite all major asset classes ending the year in negative territory, with equity markets down 15%–20%, DB pension scheme funding positions have improved, according to an analysis by Mercer. A significant increase in bond yields has reduced the value of pension scheme liabilities, more than offsetting the fall in pension scheme assets.

Companies measure DB pension scheme liabilities with respect to corporate bond yields, which have risen by c. 3% over 2022, the largest 12-month rise in over 10 years. A rise in bond yields reduces pension scheme liabilities, with ISEQ-listed companies seeing liabilities fall by 25%–50% in aggregate in 2022. The fall is despite recent high levels of realised inflation increasing pension scheme liabilities through rises in pensions in payment (for schemes that pay pension increases), and increases to former and current employees’ benefits through revaluation (indexation) or salary increases. Future inflation expectations increased by c. 0.5% over 2022, placing upward pressure on pension scheme liabilities, but these increases have generally been surpassed by the reduction in pension scheme liabilities due to the rise in bond yields.

Mercer estimates that the aggregate DB balance-sheet position for ISEQ-listed companies could be a surplus of over €1bn at the end of 2022 compared with a small surplus at the beginning of the year and very significant multibillion-euro deficits at times over the last decade, peaking at a deficit of c. €4.5bn in December 2016.

Peter Gray, Corporate Consulting Leader with Mercer, commented, “The improvement in pension scheme funding positions will be welcome news for companies, trustees and members alike. The rise in bond yields, triggered by the Central Bank’s efforts to control inflation, has seen a marked improvement in the financial position of DB pension schemes. The key questions are whether these higher yields will persist as inflation comes under control and how to take advantage of the current improved position – the corporate bond market remains volatile with yields down c. 0.35% over January.

Some schemes have derisking frameworks already in place, which will have captured some of the gains from rising bond yields, but others will need to consider what to do next. This may involve increasing the amount of bonds and related assets they hold to better match expected cashflows and reduce future exposure to changes in bond yields.

While transferring pension risk to an insurance company has traditionally been seen as too expensive, a combination of improved funding levels and a reduction in annuity pricing (again driven largely by the increase in bond yields) may present an opportunity for employers to explore annuity transactions with the scheme’s trustee board.”

Improved funding levels and recent high levels of inflation will likely see trustees and pensioner groups requesting the award of pension increases to current pensioners. The vast majority of pension schemes in Ireland do not automatically increase pensions in payment but some allow awards on a discretionary basis.

Mr. Gray noted: “Many schemes will see pensioners advocate for increases in their pensions, but this is not a straightforward decision for trustees and will likely require the consent of the sponsoring employer. Employers may be reluctant to increase their pension risk exposure by agreeing to discretionary pension increases but will be mindful of inflationary pressures facing pensioners. One solution could involve an annuity transaction, allowing an employer to manage pension risk and enabling the surplus to be used to fund a once-off pension increase. Other options could also be appropriate depending on scheme specifics and objectives, such as a combination of asset derisking and increases. Importantly, generational equity among members needs to be considered as part of any deliberations to ensure all members are treated fairly, not just current pensioners.”

Members of defined contribution (DC) schemes will inevitably have seen the value of their retirement pots fall over 2022. Most DC members will be invested in well-diversified funds containing a mix of equities, bonds and other assets. These funds will generally have fallen by 5%–15% over 2022, depending on the structure of the fund. However, it should be remembered that these funds would have delivered healthy returns over the past 10 years and, for any members looking to secure an annuity, annuity prices are now significantly lower when compared with year-end 2021.

Most importantly, members should appreciate that a DC pension is a long-term investment, potentially spanning 30+ years in many cases. Taking a longer-term view, rather than making any knee-jerk reactions, is generally the most appropriate approach. Members who are closer to retirement should consider the appropriateness of their investment choices but many default investment strategies automatically derisk as members near retirement. We would strongly encourage members to seek advice before making any decisions.

Notes for the Editor

The value of pension scheme liabilities is calculated in different ways depending on the purpose of the calculation. The data included in the Mercer analysis is based on publicly disclosed information using the approach that ISEQ-listed companies must adopt for their corporate accounts. The data underlying the analysis is refreshed as companies report their year-end accounts. Other measures are also relevant for trustees and employers considering their risk exposure.