New PwC projections predict that pension schemes will now need an extra three years to plug their rising deficits, taking the average repayment period to 11 years.
Data from a PwC study covering 98 recent defined benefit pension scheme valuations reveals that the recent trend of shorter recovery plan lengths is unlikely to continue into 2012 due to the current backdrop of rising deficits and limited cash availability. Since 2009, when the effects of the recession were still being felt and recovery plan lengths averaged 11 years, the data shows a steady drop in average recovery plan length to nine and a half years in 2010 and eight years in 2011.
But PwC predicts this downward trend will be reversed in 2012 and recovery plan lengths will match, or even surpass, the average of 11 years seen in 2009 as more valuations take place against the prevailing backdrop of depressed gilt yields and economic uncertainty.
The research reveals that over 91% of the schemes surveyed currently have a deficit and over half (57%) have a higher deficit than at their previous valuation, despite increasing deficit repayment contributions at that time.
Jeremy May, pensions partner at PwC, said:
“The difficult market combination of low gilt yields and eurozone uncertainty is hitting pension schemes hard. Many companies now face the stark choice of ploughing considerably more cash into their pension scheme, or being saddled with the debt for longer. In many cases, lack of cash availability means the decision is simple.
"Even if sponsors have access to cash, they are often choosing to reserve it to reinvest in their business and promote growth and covenant enhancements, rather than have it tied up in the pension scheme.
“The average recovery plan length provides a useful indicator of the state of the industry, but provides only part of the story and masks a wide range of recovery plans. In some cases, companies will need recovery plans considerably longer than 11 years to meet their increasing pension deficit.
“It is vital that employers take a proactive approach to managing their pension risks as they are becoming an increasing burden on UK employers, at a time when they are looking to conserve their cash.
“With average recovery plans almost certain to rise again, schemes need to ensure they have a clear justification to present to the Pensions Regulator. This should include a long-term plan for how they are going to manage the risks they are exposed to, given an employer’s ability to fund a scheme in the long term. The good news is that there are a number of options for schemes to do this, including increasing non-cash funding and hedging risks.
“Some commentators are calling for gilt yields to be smoothed to help alleviate the current pressure on cash as a result of increased deficits. Smoothing can mask the true position and produce unintended results. Whatever the position, companies should consider the current suite of approaches to manage cash, including recovery plans and methods used to set the discount rate.”
Other key findings from the study:
· 79% of sponsors with higher deficits upped contributions, whilst 43% increased their recovery plan length
· The proportion of return-seeking assets held is falling44% of schemes have considered inflation hedging but only 22% have considered hedging longevity risk;
· The link between covenant and technical provisions continues, with schemes with a stronger covenant adopting a higher discount rate.
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