Ind: Pension deficits shrink by more than 90 per cent in a year

Pension deficits shrink by more than 90 per cent in a year By James Daley, Personal Finance Editor

The Independent Published: 03 December 2007

UK pension deficits have shrunk by more than 90 per cent during 2007, with the average funding level of company schemes now at 99 per cent, according to the consultancy Aon.

The combined deficit of the UK's 200 largest final salary pension schemes has fallen from £42bn to £3bn over the 11 months of the year so far, while the average funding level has increased from 92 to 99 per cent on an FRS 17 basis.

Although some of the gains can be attributed to companies making one-off payments into schemes, the main driver has been the sharp improvement in corporate bond yields over the past few months, on the back of the credit crunch. Yields have increased as the market has priced in a greater risk of UK companies defaulting.

Pension deficits have diminished rapidly over the past few years, as new regulations have put pressure on companies to repair holes in their schemes. Those who have not taken decisive action have ended up penalised by having to pay higher levies to the Pensions Protection Fund.

By the end of November, Aon said 49 per cent of the UK's 200 largest pension funds were in surplus. "Considerable gains are likely for the second consecutive year, which will ease the short-term balance sheet pressures for company finance directors," said Marcus Hurd, senior consultant and actuary at Aon Consulting. "Volatility persists, however, and companies are advised to review pension scheme risk while the accounting balance sheet remains strong.

"Ironically, the second year of gains has been driven by the market pricing higher credit risk on corporate bonds. Critics of pensions accounting standards will argue that these gains are superficial, but the reality of company reporting is that these gains will be reflected in company accounts."

Although Aon's figures show a marked improvement in the funding of defined benefit pension schemes, they are only based on the FRS 17 accounting mechanism, which does not represent the true costs of winding up a pension scheme should its sponsoring employer go bust. Using a full buyout valuation ­ which represents the cost of buying annuities to guarantee each scheme members' pension ­ the UK's 200 largest schemes would still be many billion pounds in deficit.

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Reply to
Faubillaud
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I'd like to see more funds move to bonds and maturity-matching so that pension schemes don't end up in the crap en masse again.

FoFP

Reply to
M Holmes

"M Holmes" wrote

But that could be more risky - eg if the scheme liabilities are largely "real"...

Reply to
Tim

Surely it would be less risky, but would certainly freeze in place any existing deficit, and require its remediation by putting in cash rather than further gambling in the markets.

What could be a good idea is that as funds hit 100% of liabilities (let's say on a windup basis just to be really conservative) they should move to maturity-matching to freeze that safety in place on behalf of the members. To some extent the various funds got into a mess through their continued gambling on markets (though the longevity and discounting based on yeild issues were usually larger factors).

It's likely that our scheme will soon ask for increased payeent from members. I certainly intend to make a fuss based o the idea that if we're going to pay more to fix things, we change the investment strategy so that we know the size of the hole we're to fill, and ensure it doesn't get bigger as we fill it.

I expect it will make for quite an interesting debate...

FoFP

Reply to
M Holmes

"M Holmes" wrote

What if inflation & salary increases don't "play out" the way you were expecting?

E.g.: you hold enough bonds to be able to pay out all benefits if salaries increase at 4%pa (100% funded), BUT they actually end up increasing at 6%pa ... whooops!

Reply to
Tim

Well, if salary increases are faster than expected, then contributions will also rise if they're a fixed percentage of salaries. In a higher inflation environment, bonds will also be cheaper to buy.

Anyway, buying stocks doesn't eliminate these risks, it simply adds more risks on top of them.

FoFP

Reply to
M Holmes

"M Holmes" wrote

Yes, future contributions will be higher and will buy more bonds and so will be enough to pay for the benefits from future service. But those two points only help with the *future* accrual of benefits (in respect of service in the future); the benefits from past service need to be paid from the fund instead (or some other new source).

[For instance, imagine a deferred member of the scheme: their benefit rises with inflation, but there would be no further contributions paid for them - as their salary is zero!]

"M Holmes" wrote

The performance of equities and property *do* tend to be more aligned with inflation and salaries than FI bonds, though.

Reply to
Tim

As we've seen though, a long-term trend doesn't help if the short-term counter-trend kills the fund before the long term is reached.

FoFP

Reply to
M Holmes

The short-term isn't very relevant for a pension scheme...

Imagine that the fund under usual conditions needs to be enough to pay benefits over the next 40-100 years; if it can't cope with paying the benefits for the next 5-15 years even, then there must be a *very* big problem!!

Reply to
Tim

The thing is that funds have been killed not because they couldn't fund the next 15 years but because they were 20% underfunded measured against all future liabilites. Under ten years ago, things were allegedly going so swimmingly that many funds took "pension holidays". While the trend is their friend, the countertrend can kill them.

FoFP

Reply to
M Holmes

AFAIR many pensions moved out of shares and into more cautious investments at precisely the wrong time because people were panicking about the deficits. Employers and employees have had to dig deep to repair the mess.

The USS scheme is already fairly miserly as it only pays out

1/80ths...

Reply to
whitely525

"M Holmes" wrote

What do you mean by "killed"?

OK, they'll get into trouble with the regulators for being under-funded, but they could get back "on track" simply by calculating a suitably higher contribution rate from the employer over the next (say) 20-25 years.

There would only be a problem if the employer ceases contributing...

"M Holmes" wrote

This is why it's silly to expect funds to be "100% funded"

*all* the time - they'll inevitably go up & down over time.
Reply to
Tim

The companies have closed them.

Strangely, many employers have been demurring from doing this.

Which is A Bad Thing if a company is tempted to kill it when it's down.

FoFP

Reply to
M Holmes

wrote

Plus, of course, the extra lump sum...

Reply to
Tim

"M Holmes" wrote

Surely that's less to do with the "trend/counter-trend" issue, and more to do with the realisation that the long-term cost to the employer is higher than they wished to pay?

"M Holmes" wrote

But they *need* to do this, if they are continuing with the scheme - they can't just choose not to!

"M Holmes" wrote

Of course. But even your method will lead to trend / counter-trend (as inflation/salary incs turn out to be more or less than expected) -- so you'll never get away from that!

Reply to
Tim

many have had to do this because they closed their doors to new members. they then have an aging population of members so a greater proportion of their funds have to be held in bonds rather than shares.

Robert

Reply to
RobertL

A part of this was the 2000 stock crash ran against the funds. During teh stocks bubble, everyone was so happy at the state of the funds they took pension holidays.

So in part, the short-term trends killed the funds before they could benefit from the long-term trend in stocks.

Perhaps for that reasons, bonds and maturity-matching would be better for funds.

That's just it: they kill the scheme rather than make up the shortfall.

Not completely, but we can take out one more slice of risk.

FoFP

Reply to
M Holmes

Maybe they should have taken heed of the moral of the Genesis story of Joseph in Egypt.

Reply to
Graham Murray

Seven years of plenty and seven lean years?

I bet Gordon Brown will be wishing he'd paid more attention to that one soon.

FoFP

Reply to
M Holmes

Not that specific - do not squander (take payment holidays) in times of plenty as you never know if lean times are imminent.

Reply to
Graham Murray

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