We’ve written about the relationship between corporate bonds and pensions fund a couple of times before, but now is probably a good time to revisit the issue, given that the credit team at Dresdner/Commerzbank have just published a pensions special.
Recall that UK companies generally calculate their pensions liabilities using a discount rate-based on high-quality corporate bond yields (as opposed to say, the Netherlands, where they use the swap rates). Those yields have increased in 2008, resulting in a somewhat superficial accounting boost to companies’ pensions schemes. Just how superficial, you ask?
Dresdner/Commerzbank have a nice little data point:
The UK pension system which is still marked by a large share of DB schemes has also felt the fallout from the market turmoil. The pension protection fund (PPF) estimated that the deficit of PPF eligible DB schemes (which number around 7400) stood at £188.5bn at the end of April. This is a slight improvement over the previous month but still a far cry from the £27bn surplus a year ago. Total assets of these schemes amount to £772.3bn. In more detail, a Pension Capital Strategies (PCS) review of the FTSE 100 pension schemes reveals that their total deficit alone is estimated to be around £50bn and therefore poses a material risk to some sponsors as was already noted by the rating agency Moody’s at the start of the year. Yet as the pensions’ liabilities are discounted using AA rated corporate bond yields the impact of the increase in liability value was not as severe as compared to a case where (more normal) pre-crisis spreads above Gilts would have been applied. PCS estimates that liabilities would then see an increase by 30% on average and translate in to an increase of plan liabilities within the FTSE 100 by £100bn. . . .
The reverse is that when corporate bond yields start to fall, as they seem to be doing now (see the below chart courtesy of Ashley Thomas), those pensions liabilities go right back up. Of course, if the fall in corporate bond yields occurs in tandem with rising equity prices then the increase in the value of pension funds’ assets will help offset the effect of lower bond yields.
But, you have to ask, which one of those forces — bond yields or equity prices — exerts a greater influence on pension funds’ liabilities?
We’re not sure, but we think the Dresdner/Commerzbank credit team have given us a hint:
Conclusion and strategy implications
- Pension funds from the major economies are adversely impacted by the collapse in yield levels, less so by declining, albeit currently stabilising equity markets.
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Related links:
QE and exploding pensions – FT Alphaville
Accounting and pensions – FT Alphaville
European corporate bonds — sustainabubble? - Euro Week
All new corporate bond issues made money in 2009 – Bloomberg