The ability of FTSE 350 companies to support defined benefit pension schemes has improved from one year ago despite an increase in deficits, according to a Hymans Robertson report. This is due to strong company earnings and solid equity markets boosting company valuations, with deficits and annual contributions representing a smaller proportion as a consequence.
However, continuing volatility means that companies should embrace two recent developments that represent significant opportunities to de-risk pension schemes to reduce the chance of having to pay more cash in the future.
First is confirmation that DB scheme members can transfer into DC arrangements to take advantage of the new flexibility announced by the Chancellor in the last Budget.
Commenting, Jon Hatchett, Partner and Head of Corporate Consulting at Hymans Robertson said: “We’re likely to see a wall of money flowing out of DB schemes in the next decade as consumers embrace the Chancellor’s pension reforms and switch to DC pensions. With companies facilitating good offers we would expect 30% of members would look to transfer to DC schemes in the wake of these changes. This could remove around £100bn of risk from FTSE350 schemes and reduce long-term liabilities by £15bn. If managed well this could be a significant opportunity for companies as well as delivering the Chancellor’s vision of flexibility for all pension scheme members.
“It’s a ‘win-win’ situation, as it gives scheme members increased freedom and choice and at the same time provides companies with an opportunity to reduce deficits, shrink liabilities and improve funding levels. However, companies need to refresh their communications to ensure employees are aware of the DC transfer option and at the same time give them the help and support they need to make the right decisions.”
Second, the new code of practice on scheme funding has made the ‘sustainable growth’ of employers a key objective. Hymans Robertson recommends companies should take a slow and steady approach to funding their DB scheme, paying in lower levels of contributions over a longer time span, to support this. Doing so would reduce the risk of deficits remaining at their current level in 20 years’ time from 1 in 6 to 1 in 10, during which time companies will have paid a further £100bn into their schemes.
Commenting on how to reduce the risk of deficits worsening, Hatchett continued: “As the ability of companies to support their defined benefit scheme continues to improve, even for those firms where it has traditionally been a real burden, the temptation now will be to rush towards full funding. It may seem counterintuitive but racing towards full funding increases risk significantly. Slow and steady funding, with limited exposure to investment risk, significantly reduces the possibility of deficits worsening over the next 20 years. The Pensions Regulator has given the green light to this approach and companies should be strongly considering it. Imagine how we’d feel if we were facing the same deficits as we do today in 20 years’ time, having already spent £100bn.”
The FTSE 350 Pensions Analysis report assesses the affordability and deficit levels of DB schemes in the context of their sponsoring company’s market capitalisation and earnings, as well as the percentage of un-hedged liabilities in the scheme.
The 2014 edition reveals that two of the four key metrics measured by the report have improved with the other two remaining stable, meaning companies’ ability to support their schemes has also improved over the year:
• Security: the pension deficit expressed as pence in the pound of a company’s market capitalisation was unchanged at 1p on aggregate. The largest deficit of any company in the FTSE 350 now stands at 32p in the pound
• Affordability: the number of days of earnings to pay off the deficit fell on aggregate from 56 days to 29 days. 83% of companies could now pay off their scheme deficit with less than 6 months of earnings
• Fluctuation: un-hedged liabilities expressed as pence in the pound of market capitalisation fell from 8p to 7p. However, 38% of FTSE 350 scheme assets are still invested in growth classes, increasing investment risk
• Expenditure: the number of days of earnings to generate annual pension contributions increased from 15 days to 16 days on aggregate. 32% of the FTSE 350 now pays less than 1 week of earnings into their DB scheme
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