Tough times lie ahead for U.K. corporate pension plans, leading many to rethink asset allocations or look to non-cash contributions to shore up deficits at a time when many plan sponsors themselves will be strapped for cash.
The big picture of just how bad things are countrywide isn’t clear because of the difficulty in calculating liabilities. What is clear is that U.K. corporate plans lost billions on their investments.
The defined benefit pension plans of the U.K.’s largest 100 companies saw assets decline by £65 billion ($95.6 billion) in 2008, the equivalent of an average return of -17%, according to consultant Deloitte LLP in London.
At today’s contribution rate, it would take the companies five years to replace that loss, according to a Deloitte analysis.
Asset value declines helped push aggregate funding of the FTSE 100 plans to a £130 billion deficit as of Dec. 19, compared with a £15 billion surplus at year-end 2007. Funded status estimates are based on gains or losses on investments, contributions and liabilities.
But the 2007 figure doesn’t make for an accurate comparison, David Robbins, Deloitte pensions partner, said in an interview.
In 2007, the estimate was based on calculations using the standard accounting method of determining liabilities — namely, using corporate bond yields as the discount rate for calculating liabilities. As a result of the credit crisis, corporate bond yields have risen, thus lowering liabilities on an accounting basis.
Liabilities were about even at year-end 2008 as they were at year-end 2007, Mr. Robbins said. Thus, a more accurate funding status in 2007 would have been a deficit of about £65 billion.
Aon Consulting, which publishes a monthly funding status report for the 200 largest U.K. corporate schemes, calculated an aggregate pension 2008 year-end surplus of £3 billion, a surplus caused by liabilities declines.
Assets at the largest 200 corporate plans declined by £70 billion in 2008, however, “a combination of falling prospects for inflation (to 2.75% from 3.5%) and rising AA corporate bond yields (to 6.7% from 5.75%) have more than offset those losses” on an accounting basis, according to an Aon Consulting news release.
“Our view is that is misleading, that there is unfortunately a deficit in the pension schemes,” Deloitte’s Mr. Robbins said. He called the huge liability reductions an “unintended consequence” of accounting rules.
Aon Consulting executives agreed that surpluses “can be misleading in the current economic climate,” according to the release.
How best to calculate liabilities?
But pension consultants haven’t agreed on how to calculate aggregate liabilities. Aon continued to use the accounting formula, while Deloitte used a trustee-centric approach based on using government bond yields as a discount rate.
Deborah Cooper, principal at Mercer PLC, London, said Mercer’s year-end estimate would likely fall between the other two, but could not provide that data by press time.
The disparity among estimates is reflected in the widening yield spreads between corporates and gilts, or government bonds. Two years ago, the spread was about 0.5%; that grew to 1% in early 2008 and to more than 2.5% by year-end, Ms. Cooper said. She said many companies have said recently they won’t take advantage of the entire range of the spread.
Most of Deloitte’s clients realize that the pension surpluses they might be able to claim at year-end are “illusory,” and pension officials will adjust their calculations, Mr. Robbins said, adding that trustees generally calculate pension liabilities using government bond yields, which currently give a more accurate estimate than the corporate bond yield.
The 200 largest plans that Aon follows lost £70 billion on investments in 2008, “and companies are just fed up with it,” said Marcus Hurd, head of corporate solutions, in an interview. “It puts pressure on (trustees) to do something (to lower investment risks) once they become more affordable.
“What I’d like to see is the next time … the markets are doing well, we’ll see a lot more companies move a lot more quickly” to derisking strategies, such as buyouts or liability-driven investing, Mr. Hurd said.
The Pension Protection Fund, Surrey, England, estimated a £136 billion deficit among its nearly 7,800 member pension plans as of Nov. 30. It calculates liabilities based on the amount that “would have to be paid to an insurance company to take on the payment of Pension Protection Fund levels of compensation,” according to its annual PPF 7800 Index report. PPF spokesmen were not available for further information at press time. The PPF is the U.K. version of the Pension Benefit Guaranty Corp., Washington.
Two effects: raise contributions, re-evaluate asset allocations
Pension deficits will have two major effects on pension plans in 2009, Deloitte’s Mr. Robbins said. A trustee’s initial response to a growing deficit usually is to ask the sponsoring company to raise contributions.
“This is a very bad time to ask the company to be putting additional cash into the pension scheme,” he said. “For that reason, we need another solution.”
He expects many trustees and their sponsors will be discussing ways the company might be able to make non-cash or contingent asset contributions to pension schemes.
Mr. Robbins also expects to see many trustees re-evaluating — and changing — their asset allocations, moving out of equities and into bonds as a way to preserve capital and avoid having to raise contributions again in 2009.
Mercer’s Ms. Cooper said trustees must review their formal investment principles every three years, so a portion were already scheduled for review. “Given the way markets have changed, I would expect more trustees to be reviewing (their) strategy,” she said.
Mr. Hurd said the move among plans away from equities and toward bonds is inevitable in coming years. “The big question is the time frame in which they’ll do it,” he said, adding that now isn’t the best time to be selling equities.