Deficits have increased despite pension scheme assets rising in value. Pension liabilities will be up, on average by 15%, on account of falling corporate bond yields and a lower assumed “wedge” between RPI and CPI.
Key findings from Hymans Robertson’s “FTSE350 Pensions Indicator Report”, which sets out its views on the 31 December 2012 reporting season, include:
♦ Pension liabilities will be up, on average by 15%, on account of falling corporate bond yields and a lower assumed “wedge” between RPI and CPI.
♦ Pension scheme assets will be up, on average by 8%, with all the main asset classes aside from index linked gilts making positive returns in 2012.
♦ Deficits will be up - the aggregate FTSE350 pension deficit has increased from £67bn to £85bn during 2012.
♦ Discount rates will be c. 50bps lower this year, ranging from 4.1% to 4.6%, with longer duration schemes supporting a higher discount rate (2011 actuals: 4.6% to 5.0%).
♦ RPI assumptions will be c. 10bps lower this year, ranging from 2.5% to 3.3%, with longer duration schemes using a higher assumption (2012 actuals: 2.6% to 3.4%).
♦ CPI assumptions will range from 2.0% to 2.8% (2011 actuals: 1.8% to 2.9%). The assumed “wedge” between RPI and CPI will be lower than in 2011 – we expect an average of 0.7% (2011 average: 1.0%).
Clive Fortes, Head of Corporate Consulting at Hymans Robertson says:
“Positive returns in growth assets were insufficient to offset increased liabilities caused by falling corporate bond yields and a lower assumed “wedge” between RPI and CPI. High credit spreads masked the actual extent of pension deficits last year. The fall in credit spreads during 2012 means that reported IAS19 deficits and pension costs will be a better reflection of the pensions challenge faced by UK plc in the current low yield environment.”
Company performance in 2012
The market capitalisation of the c.220 companies in the FTSE 350 which sponsor defined benefit pension schemes has improved over 2012 from £1,700bn to £1,900bn.
“Increases in market caps reflect the market’s view that companies are in an improved financial position and are arguably better placed to support their pension schemes now. However, few companies seem to be committing the cash needed to reduce ongoing risks in their pension schemes. Notwithstanding the drain on corporate performance, only time will tell if this is the right approach.”
In 2013 the focus of FTSE 350 pension schemes will be on the following areas:
1. DB scheme closures – Around 35% of the FTSE 350 companies with DB schemes have already closed them to future accrual or controlled cost through salary capping. We expect another wave of closures in 2013 as a range of bad news factors take their toll, including: services costs increasing by 30% over the last two years with lower discount rates; administration expenses flowing through into P&L with the IAS19 changes coming into force this year; cash costs increasing as more companies complete triennial valuations in the current low yield environment; auto-enrolment costs competing for pension budgets; and further reductions in the lifetime and annual allowances increasing scheme complexity.
2. IAS19 changes – The most widely reported change in IAS19 is the removal of the credit for investing in risky assets. We expect this to have little impact for those schemes with significant bond weightings (and can even have a positive impact on profit for fully de-risked schemes), but will hurt a number of companies with high equity weightings in their scheme.
To compound this, any expense reserves held on balance sheet now will need to be released with the cost recognised through service cost as incurred. This will increase service costs, very significantly for schemes with few or no active members.
3. Nimble de-risking – Low funding levels driven by low yields mean that in many circumstances, full risk transfers (e.g. buy-outs) look expensive or are not affordable. However, disaggregating pensions risks means opportunities can be taken to hedge some risks at decent prices. Last year we flagged the attractiveness of longevity hedging, and this will continue to be an opportunity in 2013 as prices remain attractive.
4. Scheme funding – 2013 is going to be a challenging scheme funding year, particularly compared to the position in 2010 when affected schemes last did a valuation. We expect to see continued debate on discount rates and affordability, whilst also expecting a refresh of the statutory funding framework.
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