• Deficits in FTSE350 pension schemes were £73bn at the end of June 2012, virtually unchanged from the position 10 years ago.
• Over the last 10 years an estimated £175bn of deficit contributions has been paid by FTSE350 companies. This amounts to approximately 40% of the average scheme asset values over the period.
• However, funding levels shown in company accounts have only improved by around 8%, from 79% at 31 December 2002 to 87% at 30 June 2012.
Data issued by Mercer has highlighted the volatile nature of pension scheme deficits of UK companies over the past decade and how stubborn pension scheme deficits have been over that period. The data, which is taken from company accounts, highlighted fluctuations in asset and liability valuations and scheme funding levels and shows that, on an accounting basis, average scheme funding levels have improved from 79% in 2002 to 89% in 2012. However, this improvement has come at a considerable cost, with an estimated £175bn, or 40% of the average asset value, in deficit contributions having been paid by companies over the same period.
According to the consultancy, significant deficits remain despite the deficit contributions which companies will have been paying over that period. In 2002, the value of assets and liabilities in the FTSE350 in 2002 stood at £282 billion and £357 billion respectively. By 2012, assets held in the FTSE350 defined benefit schemes had increased to £501 billion while liabilities had increased to £574 billion. The data underlines the market volatility which has seen deficits oscillate from lows of £43 billion in 2007 to highs of £103 billion in 2009. According to Mercer, the volatility suggests that the risk/return position adopted by many companies in conjunction with their schemes’ trustees has not paid off, leaving company balance sheets, and potentially scheme members vulnerable to external events. Many companies are now much more active in managing this risk in light of changes in market conditions.
“The analysis illustrates the impact of the sustained fall in bond yields, equity underperformance and improving longevity over the last 10 years,” said Adrian Hartshorn, Partner in Mercer’s Financial Strategy Group. “Even removing the impact of price inflation, 2012 liability values are much higher than they were in 2002, which can be accounted for by the falling bond yields and improving longevity. Whilst defined benefit schemes appear to be in better health compared to 10 years ago because the funding level is higher, big deficits remain despite very large company contributions over the period.”
“Defined benefit pension risk management has improved over the decade but we remain concerned over the risk that defined benefit pension schemes continue to pose to UK companies. Companies need to make active decisions about the trade off between locking into more certain known costs of continuing to take risks that may or may not pay off,” he continued. “Our data underlines how market movements impact on pensions schemes. While many have adopted de-risking strategies, many other schemes remain invested in riskier assets, which have resulted in the volatile deficit figures. It is clear that much more can be done to manage pension scheme risk, and the majority of scheme now have some form of forward looking journey plan, normally established in conjunction with the employers so that both the scheme and the company’s objectives can be met These need to be actively monitored and managed to ensure a better outcome over the next decade. Those schemes that have already adopted an active approach to managing risk would have seen a much more positive outcome over the last 10 years.”
Deficits
FTSE350 deficits began the decade at £75 billion and despite an improvement in 2003 (£73 billion), subsequent years saw a worsening position with deficits standing at £86 billion by 2005. However, the situation improved over the subsequent two years with the deficit reducing to £60 billion in 2006 and then £43 billion in 2007. The impact of the financial crisis can clearly be seen with deficits increasing to £60 billion in 2008 and then to £103 billion at the end of 2009. 2010 (£64 billion) saw an easing and this trend has continued through 2011 (£61 billion). Latest figures from Mercer in August 2012 show that current FTSE350 deficits stood at £63 billion.
Funding levels
Having started off the decade with scheme funding levels at 79%, the FTSE350 saw an improvement until December 2007, when funding levels reached 92%. However, with the onset of the financial crisis, levels dropped for the next two years, standing at 80% by December 2009. While there has been an improvement over the past three years, with funding levels at 89% in December 2011 and remaining at that level on 31 August 2012 according to Mercer’s latest monthly pension’s deficit survey.
According to Ali Tayyebi, Senior Partner at Mercer and Head of UK DB Risk, “In December 2002, most companies and trustees would have had a plan to correct their deficits over at most a 10 year period. With the accounting measure of deficits at £75bn in December 2002, it would seem reasonable to estimate that total aggregate deficit contributions over the last 10 years had been at least £75bn, despite which the actual deficit has only reduced by around £10bn. Trustees and corporate sponsors have much more of a handle on risk management than previously and there are numerous solutions which are either new or more accessible to many more schemes - bulk annuity purchases, various forms of liability management exercises, Longevity Hedging, “special purpose vehicles” for asset backed funding arrangements have been developed so plenty of opportunities exist to manage risks without necessarily locking into low yields.”
One such deal is the Akzo Nobel transaction to purchase a longevity swap from Swiss Re. According to Mercer this is the sixth pension scheme longevity swap transaction completed since the start of 2011, with around £8bn of liabilities covered in total.
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