Spence & Partners latest blog for Pension Funds Online –
31st March and 5th April are common dates for pension scheme valuations. The popularity of 5th April dates back to 1997, when trustees and employers were able to squeeze in one last valuation before the Pensions Act 1995 took effect for valuations from 6th April 1997 onwards.
There is, however, a problem with valuation dates of 31st March and 5th April in 2013. And, for a change, it is a good problem! Current market conditions have improved scheme funding levels to such an extent that the results from earlier valuation dates are effectively redundant.
The increase in long-term interest rates has reduced the present value of scheme liabilities by around 10% for a typical scheme. So, if you had a scheme with £40m of assets and £50m of liabilities at 31st March, the present value of liabilities will now be around £45m (all else being equal). As a result, the deficit will have halved to around £5m.
Sponsors should therefore be alert to attempts by scheme trustees to produce payment plans based around deficit figures which are clearly too high – based on current market conditions. Making plans on such out-of-date information could have serious impacts for the scheme sponsors. When cashflows are under pressure for a variety of reasons, agreeing to pay unnecessarily high contributions to the scheme is likely to be detrimental to the long term interests of the sponsor – which would of course have knock-on effects for the scheme. Therefore, any scheme sponsor should be entering into valuation negotiations with a recent funding update to hand, meaning recovery plans and payments will be agreed on the most up-to-date figures.
The additional cash that may now be available could also be put to better use than simply pouring money into the scheme. The additional cash could be used to facilitate liability management exercises with the aim of tackling the ultimate challenge of moving the scheme closer to a position where it can buy out and wind up.
These recent conditions may persist or they may not. Either way, scheme sponsors need to have plans in place to exploit favourable market conditions (and be robust in the face of unfavourable conditions). They need to work with trustees to ensure the governance structure and technology is in place to operate their scheme on a “real time” basis rather than taking months to make decisions based on information that is already well past its sell-by date.
The vast majority of schemes missed out on opportunities to de-risk when favourable conditions emerged in early 2008 – getting with the times will ensure sponsors and trustees don’t miss out again.