The credit crunch has resulted in the cheapest pension buyout market for a decade. David Fripp, head of pensions at KPMG in Birmingham, looks at why the market conditions have helped pension funds and how companies can transfer their liabilities and reduce risk.
The pensions landscape is one of very few areas of the economy to have benefited from the credit crunch induced rise in long term corporate bond yields from five per cent to nearly seven per cent.
We have seen enormous volatility in the stock and corporate bond markets.
It is clear that higher bond yields have enabled many businesses to achieve greatly improved levels of pension funding as disclosed in their accounts. FTSE 100 companies have moved from an aggregate pension deficit of £35 billion in December 2006 to a surplus of £35 billion at March 2008 despite falling and turbulent equity markets.
In addition, the cost of transferring liabilities to a buy-out insurance company has reduced partly because of the rise in yields and partly because of many new buy-out companies coming to market and competing fiercely on price.
However, financial market conditions can change quickly, and as a result, it is imperative that companies consider securing the recent benefit they have obtained.
There are a number of options available to management teams in order to secure the pension fund and maintain a better funded status. Given a surplus in a pension scheme can be of little benefit to a sponsoring company particularly if the scheme is close to accrual, it is something worth looking at.
Even if the buy-out option, which involves a complete risk transfer, proves unattractive, there are many opportunities for pension schemes to reduce risk substantially.
The company needs to engage with the pension trustee to explain the de-risking strategies, which can involve improving diversification and hedging long term interest rates and inflation. For many, it will be surprising to discover that there can be a convergence of corporate and trustee agendas. Like the business, the trustee will often be keen to remove risk from the fund.
The effect of the financial market reaction to the credit crunch combined with intense competitive price tension has created an ideal opportunity for companies or scheme trustees to explore risk transfer or risk mitigation. This can both strengthen the security of scheme members’ benefits and the position of the sponsoring employer. Indeed, there have been some big changes in the pension buy-out market in recent years.
Clinging onto an existing strategy, just because it has worked well in the past, is a risky approach.
Local companies need to review their options now and put robust plans in place for long term funding and better risk management.