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Pension index indicates deficit

Willis Towers Watson Swiss Pension Finance Watch - Q3/2019

Investments|Retirement
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October 11, 2019

ZURICH, 11 October 2019 – Swiss companies’ pension balance sheets took a hit during Q3 as discount rates tumbled, leading to the Willis Towers Watson Pension index showing a deficit for the first time since Q2 2017. The return on assets, which was broadly in line with the return seen in Q2, did little to offset the impact of the significant fall in discount rates. Overall the illustrative funded ratio index (i.e. ratio of pension assets to pension liabilities) decreased by around 4%, as shown by Willis Towers Watson’s Pension Index, which decreased from 103.5% as at 30 June 2019 to 99.6% as at 30 September 2019.

The pension fund index of Willis Towers Watson’s Swiss Pension Finance Watch is published quarterly by the consultancy and is based on the International Accounting Standard 19 (IAS19). The index gives an indication of how the general funding position under IAS19 has changed from quarter to quarter, as opposed to giving the typical funding ratio of Swiss pension plans.

Companies need to face negative discount rates

Q3 put a question mark over the term “discount rate”. “During Q3 we saw for the first time that Switzerland has experienced negative discount rates for IAS19 accounting purposes,” comments Adam Casey, Head of Corporate Retirement Consulting at Willis Towers Watson in Zurich. Whilst discount rates rebounded slightly during September, they remain negative at shorter durations and barely positive at longer durations. Negative discount rates mean that future liabilities are no longer being discounted to calculate their value in today’s terms but are instead being inflated. “Whilst it is impossible to predict what discount rates will do in Q4, we are preparing companies for the strange but real possibility of negative discount rates for the 2019 IAS 19 valuations and indeed some have already had a negative discount rate for reporting at 30 September 2019”, he adds. This is a good time to make sure that the assumptions used for corporate accounting purposes are the current best estimate of the experience of the plan. Adjustments to certain assumptions that have not been reviewed in recent years could lead to some much-needed relief in the pension plan liability when updated to reflect actual experience.

It is important that companies are aware of the current market conditions and how they impact the pension plans in their own corporate accounts. This can help companies prepare for any significant changes in international accounting results ahead of time. Companies can also seek to optimise risk exposure by reviewing the design of their pension plans.

Address risk exposure over different time horizons

Whilst market uncertainty in the face of trade conflict, political instability and the prolonged economic cycle continues, investors have sought the relative safety of high-quality bonds, which has driven down yields even further. Still, return-seeking assets, such as equities, have remained positive as central banks once again loosened monetary policy, as economic growth forecasts weakened.

During Q3 we saw for the first time that Switzerland has experienced negative discount rates for IAS19 accounting purposes.”

Adam Casey
Head of Corporate Retirement Consulting, Willis Towers Watson, Zürich

It is imperative that Boards of Trustees are not unduly influenced by short-term changes in market sentiment. While markets remain volatile and with recession a distinct possibility in the near future, Boards should focus on their longer-term, strategic positioning across different asset classes. As Michael Valentine, Investment Consultant at Willis Towers Watson in Zurich advises: “Retaining a well-diversified portfolio across different risk drivers is the best way for pension funds to ride out shorter term volatility. The long investment horizon that pension funds have essentially amounts to a competitive advantage, which is in danger of being rapidly eroded if too much emphasis is placed on trying to time markets. Pension funds can address their various risk exposures over different time horizons, including rewarded and unrewarded risks, by conducting an ALM (Asset Liability Model) study, every 2-3 years. This not only factors in capital market aspects but aligns the portfolio’s strategy to the pension fund’s liabilities. Furthermore, the dramatic increase in interest in sustainable investment approaches is entirely consistent with a pension fund’s objectives and these aspects should ideally be incorporated, when deriving investment beliefs at the start of any ALM.”

Increase in liability values partially offset by asset returns

The asset market finished Q3 with many indices close to their all-time high around, despite a shaky August. The return of 12.2% in 2019 so far, as represented by Pictet’s 2005 BVG-40 plus Index, which includes a healthy return of 2.2% during Q3, has been welcomed by companies with significant balance sheet positions as corporate bond yields continue to tighten. As corporate bond yields plunged by a further 33 basis points to reach essentially an all-time low for Switzerland, pension liabilities increased by 6.3%. The combined effect of the increase in pension liabilities and the minimally offsetting positive asset returns over the quarter lead to the index falling to below 100% for the first time in two and a half years.

The Pension Index measures the movement in the ratio of the assets to the defined benefit obligation  of a sample pension plan (index level 100% on 31.12.2006).
Willis Towers Watson Pension Index - Switzerland

The Pension Index measures the movement in the ratio of the assets to the defined benefit obligation of a sample pension plan (index level 100% on 31.12.2006).

Background information on the study

Swiss Pension Finance Watch reviews quarterly how capital market performance affects pension plan financing in Switzerland. The study is part of the Global Pension Finance Watch from Willis Towers Watson which includes results back to 2000 for major retirement markets worldwide. The results are published quarterly with a focus on linked asset/liability results. It covers pension plans in Brazil, Canada, the Euro-zone, Japan, Switzerland, the U.K. and the U.S.

The impact of capital markets on these pension plans is two-fold:

  • Investment performance on fund assets
  • Changes in economic assumptions on plan liabilities (as measured by international accounting standards)

Willis Towers Watson's model defines a benchmark pension plan that is intended to be representative of the pension liabilities and plan assets (including asset mix) that are typically found in each global market. The impact of movements in capital markets on assets and liabilities is combined to produce a Pension Index which reflects the movement in the funding level of the benchmark pension plan.

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