Consulting Actuaries

2018 - Just like the weather!

Royal London Consulting Actuaries

20 December 2018

The only consistent part of our weather is its constant ability to change. For the finances of defined benefit (DB) pension schemes 2018 has been no different.

For some, the finances of their DB pension scheme at the end of 2018 will be similar to the position at the start, meaning the pension scheme is swiftly put aside. For others who have been battered by the storms, it may be yet another year of problems.

Equity markets have been volatile and diverse. Corporate bond yields have risen and inflation expectations have remained relatively benign. Meanwhile the outcome of the Lloyds court case is likely to add billions to the cost of DB pension schemes for UK plc.

On the liability side:

Corporate bond yields have increased over 2018

The chart below shows the yield on an AA corporate bond index over 2018 to 6 December, together with the 15 year spot rate for price inflation.


Sources: iBoxx and Bank of England


Corporate bond yields have increased steadily over 2018, although this has been partly offset by the recent uncertainty around Brexit. Even a quarter per cent rise will help control the increased costs of recent years. In addition, future inflation expectations have been relatively benign, currently being just above expectations at the beginning of the year.

Overall this means that the value of DB pension scheme liabilities can be expected to have decreased over 2018; possibly by 2% to 4%.

GMP equalisation

The autumnal storm for pension schemes was the recent Lloyds Bank court case. For schemes that were contracted-out between 1990 and 1997, there is now a definite requirement to adjust members’ benefits for sex-inequalities caused by Guaranteed Minimum Pensions (GMP). (See our article on the Lloyds case ‘GMP conundrum…not quite solved’.) This will increase scheme liabilities, with some commentators estimating increases of up to 4%. More immediately, due to company accounting rules, some auditors are expecting to see this cost coming through the sponsor’s P&L this year.

On the asset side:

Diversification strategy will be the differentiator

Total returns on the main asset classes, before expenses, over 2018 to 6 December are shown below.

Total return over 2018 to 6 December 

UK Equities 

-  6.8%

Overseas Equities 

+  2.6%

Fixed Interest Gilts

-   0.3%

Index-Linked Gilts 

+  0.3%

Corporate Bonds

-   0.8%


+   5.2%

The star performer so far in 2018 has been property; this is despite concerns around Brexit and slowing UK and global economic growth.

The UK equity market has performed poorly, buffeted by both the severe storm of Brexit and the cooling of the global growth expectations.

Overseas equity markets have had mixed fortunes, but still outshone the UK.  US exposure has been critical to good performance. Until recently, the sun has shone on North America as the US equity bull market continued almost unabated. There has been a recent drop as tech stocks have pulled down the market. However dollar strength/sterling weakness has delivered a return of about + 8.1% in sterling terms for the year to date. Meanwhile Emerging Market and European equity have both disappointed (returning about – 5.3% and -7.2% respectively) due to fears about global trade and the knock on effects of Brexit. Currency hedging will also play a part given sterling weakness, particularly against the dollar.

Government gilts, both fixed interest and index-linked, have broadly flat-lined over 2018. This is a similar story to 2017. The gilts bubble persists, with demand for long dated gilts remaining strong. Meanwhile, the flip side of corporate bond yields rising is that returns have been negative to date, particularly at longer durations.

The overall investment performance for a particular DB scheme will crucially depend on

  • the mix of asset classes held, particularly the proportion held in property and US equity
  • the investment manager’s strategy on mitigating currency changes, if you invest overseas

What does this mean for company accounts in 2018/19?

For a typical DB pension scheme, modelled as below, and ignoring the impact of the Lloyds court case, we expect that the accounting position will have improved, with the assets likely to have grown by 1-3% more than the liabilities. However the effect of equalising for GMPs could largely offset this improvement. The outcome may be that the financial position at the end of 2018 is similar to that at the start.  

Of course, the experience of a particular DB scheme may be very different. Plus our analysis ignores the impact of any deficit repair contributions being paid.


If you would like to discuss this matter further please contact us.



In deriving the above illustrative figures, we have assumed that the duration of the DB pension scheme’s liabilities is 15 years and 50% of both pension increases in deferment and in payment are linked to price inflation. The assets are assumed to be invested broadly 60% equities (equally split between UK and overseas) 40% bonds (equally split between fixed interest gilts, index linked gilts and corporate bonds). The investment manager is assumed not to hedge currency risk and gilt funds are assumed to hold all stocks. The DB pension scheme is assumed to have no surplus or deficit at the start of 2018 and no allowance is made for any contributions paid by companies to address a funding deficit.

We have measured UK equity performance by reference to the FTSE All Share Index, overseas equity performance by reference to the FTSE Global All Cap ex UK Index, fixed interest gilt performance by reference to the FTSE Gilts All Stocks Index, index-linked gilt performance by reference to the FTSE Index Linked Gilts All Stocks Index, corporate bond performance by reference to the Royal London corporate bond fund and property performance by reference to the Royal London property fund. US equity, Emerging Market equity and European equity performance have been measured by reference to the BlackRock Aquila US equity index fund, the BlackRock emerging markets tracker fund and the Royal London European equity fund respectively.