Stock market volatility - impact on company pensions

As the markets closed yesterday (22 January), the effect of market movements on the UK's largest company pension schemes left them showing an aggregate deficit of £13 bn, according to actuaries at Mercer. This compared to a deficit of £25bn on Monday 21 January.

As company pension funds invest for the long term, the current market volatility should be of limited concern to well-managed pension funds that accept measured amounts of exposure to equity volatility as part of a robust financial strategy.

Tim Keogh, a worldwide partner at Mercer, commented on the impact on defined benefit schemes: "Many of the UK's largest companies have planned for the contingency of a possible market downturn and either taken steps to derisk their schemes or concluded they can tolerate the risks. Those that have kept their eyes closed hoping for the best will have more reason to worry.

"In conditions like these, the pensions regulatory system is very flexible and knee-jerk reactions are neither required nor desirable. So the message should be 'don't panic'."

He added, however: "Longer-term, if everything stabilises at a lower level more funding will be needed over time.

"Looking at the broader picture, what's important is if this development means the value of corporate Britain declines into the foreseeable future. That would mean the burden of meeting existing pension promises would take a larger proportion of the wealth that companies create."

Commenting on the impact of market volatility on individual members of defined benefit schemes and their trustees representatives, Mr Keogh added: "Most members of defined benefit schemes should not be overly concerned. A fall in the value of their scheme's assets is probably less significant than the impact of any recession on their employer as the ultimate guarantor. But no-one is really predicting mass bankruptcy.

"There are a minority of defined benefit schemes with weak sponsors and aggressive 'stay-in-the-casino' investment strategies. These schemes are more at risk now and, whilst their members are partially protected by the Pension Protection Fund, the potential for an increased burden on everyone else to fund their risks is greater if the market stays down."

Simon Pearse, an investment consultant at Mercer, commented on the implications for defined contribution schemes and their members: "The impact on members of defined contribution schemes could be more significant. Without a benefit guarantee from their employer, they bear the risks of any downturn in investment performance, and so a market fall is more evident in terms of reduced fund levels. However, members should already be taking a long-term view of their investments and not be tempted to make any quick decisions to move away from their plan strategy, without sufficient justification. Any decision on a change in asset allocation should be made for the long-term, taking advice as necessary."

He added: "If members have not reviewed their investment options recently then this is a timely reminder to do so and to make sure they still fit in with their long-term plans. Ultimately they need to be comfortable that they can cope with further falls if these were to happen, particularly if they are approaching retirement. This could mean moving to asset classes with more stable returns but with a lower potential for high growth. In the longer term this may mean paying a higher regular contribution into their fund to compensate. "

He continued: "Similarly, trustees or sponsors may want to review the default fund options offered to members to ensure that the risk being taken is efficient and suitably rewarded.

"Trustees may also wish to consider some form of communication to members. In particular, if markets remain volatile or continue to fall, we would suggest that trustees consider some form of communication, perhaps to accompany the annual benefit statements. Many members will have only seen rising markets and seeing the current market conditions will understandably be an issue of concern to them. Trustees can do much to reassure such them and put the current conditions into the longer term context."