The 2011 year end IAS19 deficit masks a much more significant fall in underlying funding positions, as AA credit spreads have widened to 1.7% making IAS19 a weaker funding measure than at the start of the year.
Key findings from Hymans Robertson’s “FTSE350 Pensions Indicator Report”, which examines the state of UK pension finances in 31 December 2011 company accounts, include:
- The aggregate IAS19 FTSE350 funding position has worsened during 2011 from a £43bn deficit at the start of the year to a £67bn deficit at the end of the year.
- This is primarily because of a 70 basis point fall in AA rated corporate bond yields that are used to measure pension liabilities under IAS19 and is exacerbated by poor returns in growth assets.
- This masks a much greater fall in UK government bond yields of 120 basis points resulting in credit spreads on AA rated corporate bonds of 1.7%. This is approaching a level last seen in the wake of the 2008 Lehman Brothers crisis.
- In spite of poor returns on growth assets and distressed European sovereign debt in 2011, many companies will disclose only marginally higher IAS19 deficits at this year end. This however hides the substantial increase in the underlying funding deficits for most pension schemes, necessitating the continuation of current levels of pension deficit funding or possibly even increased contributions.
- Whereas 92% of companies used a discount rate within 0.1% of the iBoxx index in 2010, we expect a wider spread of IAS19 discount rates this year from 4.7% to over 5.0%, reflecting a steeper yield curve and greater dispersion in credit spreads.
- We also expect a drift upwards in the assumed differential between the CPI and RPI assumption from 0.7% in 2010 to possibly as high as 1.0% in 2011. This reflects increasing analysis suggesting there are greater technical differences between the two inflation measures than were previously evident.
Clive Fortes, Head of Corporate Consulting at Hymans Robertson says:
“In spite of poor returns on growth assets and the impact of distressed European sovereign debt, many companies’ 2011 financial statements will only disclose marginally higher IAS19 deficits this year. This will not however translate into reduced funding requirements for pension schemes and current levels of pension deficit funding are likely to need to be maintained or even increased.”
Company performance in 2011
The report predicts that company performances will have suffered during 2011 although with very mixed results between different market sectors. It shows that the market capitalisation of the c.220 companies in the FTSE350 which sponsor defined benefit pension schemes has reduced from £1,900bn at the start of the year to £1,700bn at the end of the year.
“At the start of the year a typical FTSE350 company had a pension deficit of 2p in the pound market value. We expect that this will have increased during 2011 to around 4p in the pound, primarily due to a fall in company values. This position is likely to understate companies’ underlying exposure given the flattering effect on IAS 19 deficits of the widening credit spreads.
“Companies will need to revisit their de-risking plans to ensure they are still fit for purpose. We would not advocate de-risking at any cost. However, existing triggers may need to be revised downwards to take advantage of opportunities which do arise in the future”.
In 2012 the focus of FTSE 350 pension schemes will be on the following areas:
1. The European sovereign debt crisis is having a profound impact on UK pension schemes. We expect that this will lead to more difficult funding discussions for pension schemes with 2011 / 2012 valuation dates. As a result, we expect to see increased recovery plans and greater use of asset backed funding structures to mitigate any increased contribution requirements.
2. With historically low gilt yields, we expect de-risking opportunities to be initially focused on longevity and inflation risk rather than looking at buy-ins. Consequently, this will, leave a pent up demand to hedge interest rate risk leading to a rapid increase in demand for gilts and buy-ins should gilt yields rise. However the pension market is sensitive to the external political environment and therefore depending on changes that may occur in the wider European political and economic landscape we may witness a high level of activity in the buy-out market towards the end of the year.
3. Notwithstanding regulatory concern over liability management, we expect that companies will continue to selectively implement benefits options, such as flexible income drawdown, to manage their liability risks.
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