2020 valuations – what is lurking behind the corner?

Pension schemes have been experiencing a turbulent time of late with those that are not well hedged against interest rates suffering from falling funding levels. Add to this market uncertainty around the world driven by the US trade wars, and Brexit, and many will be hoping for a quieter 2020.

I think that this will be wishful thinking.

GMP equalisation is a problem that the industry is still grappling with. A key issue is that the benefit for members is expected to be small, but the cost of implementation is high, with little or no benefits to the sponsor on the horizon. There remains a level of uncertainty, relating particularly to the tax implications of any uplift in benefits. And whilst the GMP working party has issued its first guidance paper, it still feels like most schemes are waiting to see who moves first, with perhaps only those who are looking to buy-out in the near future actually taking action. 

However, as depressing as GMP equalisation makes me feel, I am thinking about those schemes with 2020 valuations and what they might hold.

Schemes which had valuations in 2019 saw 3 years of positive asset returns and lower longevity expectations offsetting the impact of falls in gilt yields; in many cases leading to broadly stable funding deficits or even improvements where schemes were interest rate hedged. For schemes without any interest rate hedging the position may not have been so rosy. In 2020 what might the position be?

Well that depends on

  • Gilt yields – long-term gilt yields continued to fall over 2019 with 30-year gilt yields falling below 1% for the first time in August and there is no sign of a sustained rise. This is consistent with what we have seen in other developed markets and is being driven by concerns over slowdown in the global economy. However, over the next year or so, UK gilt yields will also be impacted by Brexit, the final timing and details of any deal and the long-term trading relationship with the EU. For schemes that are not fully hedged, the fall in gilt yields since the 2017 valuation date will contribute towards rises in deficits. 
  • Asset returns – we have seen positive returns from equities and other growth assets over the last three years and even more so for schemes that weren’t fully currency hedged due to losses in the value of sterling. This was a positive factor for many schemes with 2019 valuations, which saw these rises in assets offset any increase in deficit caused by being under interest rate hedged. However, we are seeing signs of a global slowdown and rising trade concerns, which may well lead to market volatility and a potential downturn over 2020. This is combined with rising value of the pound on the back of a possible Brexit deal which will reduce the impact of any unhedged currency gains. Taken together, this could lead to asset values falling back for 2020 valuations.
  • Longevity – many schemes saw improvements to their funding levels as a result in updating to the latest CMI mortality projection tables which for 2019 valuations could have led to a fall in liabilities of  around 4%. However, over 2019 fewer people have died than expected based on the ONS data for England and Wales. In fact, the cumulative improvement in mortality for the first half of 2019 is higher than in any of the previous ten years. So, does this mean that the savings we saw for the 2019 valuations won’t be there in 2020? Certainly, there may be more conservatism in 2020 valuations to reflect this and this experience is expected to feed through to the next set of CMI projection tables.

This will then be compounded by the ‘comply or explain’ approach of The Pensions Regulator around valuations and long-term funding targets which we expect to come into force in 2020/21. Whilst the exact timing of any new legislation is uncertain in the current political climate, TPR seems to be pushing ahead with their plans. In particular, the long-term funding target will highlight the likelihood of schemes reaching, as a minimum, a self-sufficiency funding level and over what time period. Where this is a long way out this may lead to greater Regulator intervention, particularly for weaker sponsoring employers. Further, there is increasing focus on recovery plan length and seven is the new ten, with less flexibility to lengthen recovery plans without explaining.

In summary …

So, overall, we may see relatively weak asset values, lower gilt yields and potentially static longevity compared to 2017 valuations, which taken together are likely to result in worse funding positions. At the same time there will be greater focus from The Pensions Regulator to ensure that schemes are moving to a fully funded position over shorter timeframes. This is going to lead to some potentially difficult conversations between companies and trustees. It will be important to have a joint clear understanding on the future of the scheme. Companies and trustees will have to work together to achieve an outcome that is both viable and meets the expectations of the Regulator.