Defined benefit pension schemes at Iseq-listed companies have moved into a surplus of €1bn since the beginning of the year, according to estimates from Mercer.

Defined benefit (DB) pension scheme liabilities are measured with respect to bond yields, and a "significant" increase in corporate bond yields of c. 2% this year has reduced the value of scheme liabilities by c. 25-30%, more than offsetting a recent fall in "growth" assets such as equities, which fell c. 20% in the first six months of 2022.

While inflation expectations have also increased this year, most pension scheme liabilities are typically less sensitive to inflation than they are to changes in bond yields.

The fall in liabilities has outweighed the negative returns on pension scheme assets, with schemes also benefitting from risk management strategies such as the structured de-risking of their asset portfolios.

Beyond the close to €1bn swing in value of defined benefit pension schemes in the first six months of the year, the balance sheet's health is a change from the multi-billion euro deficits seen over the past decade, peaking at €4.5bn in December 2016.

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Christopher Delaney, corporate pensions accounting leader at Mercer, commented, “If the current conditions persist to year-end, the position of DB pension schemes on company balance sheets will have moved into a meaningful surplus for the first time in many years.

"The fall in liability values brought about by large increases in bond yields has more than offset the rise in inflation expectations and the significant negative returns from equities and other higher volatility growth assets. For the minority of companies with an open DB scheme, the annual P&L cost of providing a DB pension to employees may reduce significantly.

"However, the cash contributions that companies are required to pay into their schemes will not automatically reflect the improvements in funding levels, as these contribution rates are typically calculated every three years.

"Contribution rates agreed during the last 12-18 months are unlikely to take account of the recent improvement in funding levels, and companies impacted by this may wish to engage with the trustees of their pension schemes to explore whether their contribution rates can be revised to take account of recent changes.”

Mercer also said pension fund trustees should have seen improvements in their statutory funding levels which are generally also an important consideration.

While improving funding levels will be welcomed by trustees responsible for the management of scheme assets and investment strategy, they will be conscious of the potential volatility in funding levels going forward, given the uncertain economic outlook.

Delaney noted: “Many schemes that have already put robust structures in place to move their investments from equities and other growth assets into government and corporate bonds will have already benefited from a de-risking of their asset portfolio as funding levels improved.

"However, other schemes should review their investment strategy and could look to use the recent improvement in funding positions to remove some risk by implementing a more matched investment strategy or consider settlement options such as bulk annuity contracts with insurers.”

Members of defined contribution schemes will inevitably have seen the value of their retirement funds fall, with diversified funds generally down between 5% to 15% year to date following a long period of positive returns.

Mercer cautioned against any knee jerk reactions, especially when the market is so volatile, as it may ultimately only serve to lock in losses.

Photo: Christopher Delaney.