• Mercer outlines funded status for Defined Benefit (DB) schemes across 4 major economies
• Over 9 months funded status for schemes in UK improves but declines in US, Canada and Netherlands
• Data illustrates country risk for multinationals managing DB obligations
The funded status of Defined Benefit (DB) pension schemes in the US, Canada and the Netherlands has broadly declined since December 2011 while improvements have been seen in the UK, according to data released by Mercer. The greatest decline has taken place in the Netherlands where funded status has fallen from 96% to 80% due to drops in the discount rate used to measure pension liabilities. According to Mercer, as the interest rate used to measure the liabilities has fallen in the Eurozone, so liabilities across the region have increased - the picture in the Netherlands is replicated across the Eurozone. Multinationals with pension obligations in Germany, Netherlands and Ireland, in particular, will all be facing larger liabilities, says the consultancy.
In the UK, the funded status for DB schemes has, despite fluctuations, remained broadly level over the period until September when there was a sharp improvement to 92%. Those in the US have declined from 75% to 73% while those in Canada have declined from 87% to 83%. The cause of movement in each market is primarily declining discount rates combined with lacklustre asset performance. In the UK, however, the yield on high quality corporate bonds increased and the market implied long-term inflation reduced leading to a 33% reduction in FTSE350 deficits for the month of September.
“There’s a multitude of risks facing multinationals with only a single DB scheme,” said Frank Oldham, Senior Partner and Global Head of Mercer’s DB risk group, “but this data shows the scale of the risks and problems facing companies with schemes in multiple geographies. It has not been uncommon for funding levels to move in different directions in some markets over the same month. It is crucial therefore that multinationals can monitor their cross-country exposure and react quickly to capitalise on local opportunities.
“For example, a multinational should be able to readily compare a buy-in of the retiree liability in the UK, with a lump sum cash-out exercise for deferred vested participants in the US - and be ready to execute quickly. We are working with an increasing number of multinationals to help them plan and ready themselves to take action and to monitor the opportunities presented by market movements more pro-actively”
An analysis of the Eurostoxx 600, by Mercer in July 2012 highlighted the scale of pension risk facing multinationals in Europe. The report showed that while corporate earnings have increased since 2008, DB pensions continued to cause a significant dilution of company earnings and are now larger relative to market capitalisation than in 2006. Pension expense now accounts for around 10% of earnings and pension deficits represent 4.8% of market cap in 2010/11 compared to 2.9% in 2007/8.
“If these deficits continue to worsen,” commented Mr Oldham, “the cost of maintaining pensions for multinationals or organisations with operations in the UK will shoot up. No executive wants to be worrying more about the pension scheme than the business, so risk management is vital.”
While the situation for each multinational depends on how their pension risk is distributed across markets and across asset classes, strategies to control the impact of market fluctuations on pension’s earnings are essentially the same across all markets. They cover dynamic investment policies to liability-driven investing to risk transfer strategies, including lump-sum cash-outs and annuitisation.
“Nevertheless, multinational organisations need to be mindful of the regulatory nuances in each market, and the fact that markets are not perfectly correlated, so monitoring needs to take place at a local level” commented David Newman, international consulting leader in New York, and multinational DB risk leader.
“As multinational sponsors of defined benefit plans go through the budgeting process for 2013”, commented Mr Newman, “the projected impact of the decline in funded status in these plans will have a significant impact on 2013 earnings. They may outstrip the impact on 2012 earnings, especially for those reporting under US GAAP where the impact will be leveraged due to the requirement to amortize any losses in expense.”
In some markets like the US, Netherlands and Ireland, the regulators have provided more clarity on the short-term minimum cash requirements giving DB scheme sponsors more leeway when addressing their scheme deficits. In the US, there may be an opportunity to lower short-term cash requirements. While these regulatory interventions may help in the short-term, multinationals need to be mindful of the true underlying deficit.
The typical funding levels are estimated based on the average funding levels for companies listed in the S&P 1500 (US), the FTSE 350 (UK), the S&P/TSX (Canada) and the AEX/AMX (Netherlands). While not covered in this data, the funded status of other plans in the euro-zone will have experienced a similar increase in pension liabilities due to the decline in discount rates.
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