Rising bond yields won’t solve defined benefit schemes issues

The world has become used to interest rates barely visible to the naked eye but it looks as though the tide has turned with the Federal Reserve in the US raising rates in December for only the second time in the last decade.

The market has been guided to expect more of the same in 2017. And – potentially buying into the idea that the Trump administration will prove reflationary – seems to give more credence to the guidance than it did last year.
That may be good news for defined benefit corporate pension schemes labouring under valuation shortfalls, with the rise in bond yields increasing discount rates, thereby reducing deficits.

But that, of course, is only part of the story.

Rising yields look unlikely to defuse the debate about how these pension fund liabilities should be valued and who should meet major shortfalls after years of underfunding – the most notable recent example being BHS.
Some have argued recently that pension schemes should be valued according to the returns on the actual underlying assets held not just benchmark bond yields. Such an approach might return equities to favour for pension fund managers – an asset class which delivered strong returns in 2016.

Others have also pointed out that given the remarkably low borrowing costs still available corporates should be borrowing to fund their pension shortfalls – despite the drawback that rising bonds yields, if sustained, will lead to higher debt service costs.

And BHS continues to loom over the issue, provoking the House of Commons Work and Pensions Committee to recommend in its latest report a trebling of the fines the regulator can impose on employers avoiding their responsibilities.

With a Green Paper on pension funding due early this year, the topic looks certain to run further in 2017.

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