Falling Gilt yields to weigh heavily on funding

Plummeting Gilt yields will likely cause further funding problems for defined benefit pension schemes, as investors pile into safe haven assets amid the Covid-19 outbreak, according to pensions consultancy Barnett Waddingham.

Short-term fixed-interest Gilt yields turned negative for the first time in history in March, exacerbated by the cut in the Bank of England base rate by 50 basis points to 0.25%.

Yields on 10-year government debt also fell to an all-time low of 0.08% that same month.

The price of UK government debt was also driven up after the price of Brent Crude crashed by a fifth when Saudi Arabia instigated a price war, which also caused the share prices of UK-listed oil majors such as BP and Royal Dutch Shell to lose as much as a fifth of their market value in just one day.

“When combined with the falls in equity markets, the fall in yields is likely to mean funding problems for many UK DB schemes – particularly those with actuarial valuations coming up soon,” said Barnett Waddingham principal Ian Mills. “It will have caused many schemes’ liability values to rise, at the same time as their assets have fallen, opening-up the spectre of significant deficits to address.”

However, given yields have been falling, the expected adverse economic impact of the virus has caused markets to anticipate lower future price inflation, Mills said.

“Those DB schemes who pay inflationary increases to their members may now be expecting lower pay-outs in future, which will offset some of the bad news,” he added.

The upcoming consultation on reforming the RPI calculation methodology may even help some schemes further in this regard, Mills said.

“Our advice, as always, is that schemes should look to analyse and mitigate risks, through hedging and diversification,” he added. “This is even more important than usual when markets are jittery and volatility is heightened.”