Yesterday’s market gains arrived fractionally too late for companies preparing to update investors on the health of their defined benefit pension schemes through their annual accounts, according to Towers Watson.
The most common accounting period for large UK companies is the year to 31 December. These companies must disclose pension deficits based on market conditions before yesterday’s changes. Towers Watson estimates that, for the FTSE 100 as a whole, aggregate deficits were £35 billion on 31 December 2012 (down slightly from £39 billion a year earlier). Following market movements on 2 January, they had contracted to £27 billion.
John Ball, head of UK pensions at Towers Watson, said: “Total pension scheme assets did not actually increase much yesterday - losses on their increasingly large bond holdings will have almost offset the gains on their equities. However, deficits still fell sharply because the liabilities in company accounts look smaller when corporate bonds lose value. This change came too late to include in the disclosures for 2012 which companies will publish over the next few months: accounting numbers are snapshots representing market conditions at the time they are taken.
“Companies may have been able to give investors a more rosy picture if the US ‘fiscal cliff negotiations had not gone right down to the wire. Nonetheless, with deficits having been £48 billion going into the second half of November, the 31 December position may typically be a little better than some had prepared for.”
Yesterday’s developments provide another reminder that volatile markets present opportunities for pension schemes to lock in gains: although the pension deficits in company accounts do not reflect the full cost of making all members’ benefits secure, they do illustrate how quickly things can change.
John Ball said: “During the course of 2012, aggregate deficits were as high as £78 billion in May and as low as £16 billion in September. As well as keeping on top of day-to-day movements, schemes should ensure that someone has the authority to take decisions when trigger points are reached and before markets turn again. There are lots of reasons why conditions could remain volatile in 2013 but schemes who think that the next crunch point in US politicians’ negotiations could see another market reaction may want to circle 1 March and the preceding days in their calendars.”
By 31 December 2012, pension scheme assets had caught up with where liabilities were 12 months earlier, helped by 12% returns on UK equities, including dividends. However, deficits were not eliminated because liabilities grew too. The interest rates on high quality corporate bonds fell during 2012; under international accounting standards, this translates directly into bigger pension liabilities. The impact of this was cushioned a little by companies being able to assume that their schemes will pay smaller pension increases than they had been expecting, partly because of possible changes to the way that RPI inflation will be calculated in future.
In the Eurozone, the drop in corporate bond yields has been about three times as sharp as in the UK, meaning that pension deficits will often look bigger than they did a year earlier. John Ball said: “Corporate bond yields have been coming down around the world. In the Eurozone, they have fallen off a cliff. As a result, some European companies face having to report that pension obligations are making a much bigger dent in their balance sheets than they disclosed a year ago.”
Behind the small aggregate fall in UK deficits during 2012, there will be a wide variety of outcomes for different companies. John Ball said: “Companies whose pension payments stretch further into the future should be less badly affected because corporate bond yields held up better at longer durations. Also, those with hedging strategies in place will be less affected by changes to bond yields and inflation expectations because their assets will change in value in the same way.”
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