The aggregate funding position on an accounting basis for FTSE 350 pension funds remains stable retaining a healthy surplus, despite bond yields falling since the end of 2022, according to Mercer’s Pensions Risk Survey data analysis for January 2023.
As Mercer Principal, Matt Smith explains, while surplus may be the ‘new normal, there is the potential for greater friction between sponsors and trustees on how any surplus is distributed.
“The expectation is that 2023 will be a year of further economic challenges with fears of a recession, higher price rises for longer and further rises in interest rates,” said Mr Smith. “The continued uncertainty is yet another reminder for trustees and sponsors to be proactive in understanding the risks and what actions they can take to mitigate these.
“At the same time, the spotlight is being turned on the growing divide between accounting and regulatory funding requirements: on one hand sponsors are increasingly disclosing accounting surpluses on their balance sheets, but on the other hand contributions are still being paid to support journey plans towards a low dependency (on the employer) target.
“When we consider this position alongside the new DB funding code consultation there are certain circumstances where this may create friction between trustees and sponsors: those where more cash is needed to support journey plans despite a strong ongoing funding position. The pressure is upwards – higher funding, against a firmer (higher liability) target, and funded in the scheme – so surpluses may soon be a real question for trustees and sponsors to contemplate.”
Mr Smith explained that the friction this creates is on the use of any surplus.
“Distribution of surplus is something of a lottery, based on the wording within scheme rules, but additionally, the timeframe to returning any surplus to the sponsor and the tax payable imposes additional barriers to sponsors supporting journey planning with further contributions.
“A question that may need considering more broadly, by the Government, is whether the current rules around the use or release of surplus remain appropriate in light of the new regulations and funding code, or whether there is an alternative to holding all the assets in the scheme in order to achieve low dependency on the sponsor.”
Mercer’s Pensions Risk Survey data analysis for January 2023 shows that the accounting surplus of defined benefit (DB) pension schemes for the UK’s 350 largest listed companies decreased marginally to £33bn at the end of January 2023. The present value of liabilities rose from £595bn at 31 December 2022 to £622bn at the end of January 2023 driven by a fall in corporate bond yields, offset to an extent by a fall in future implied inflation expectations. Asset values also rose over the period to £655bn compared to £630bn at the end of December 2022, absorbing the majority of the impact of the liability increase.
Mercer’s Pensions Risk Survey data relates to about 50% of all UK pension scheme liabilities, with analysis focused on pension deficits calculated using the approach companies have to adopt for their corporate accounts. The data underlying the survey is refreshed as companies report their year-end accounts. Other measures are also relevant for trustees and employers considering their risk exposure. Data published by the Pensions Regulator and elsewhere tells a similar story.
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