New U.K. pension funding regulations might whipsaw many companies making deficit-recovery contributions to their defined benefit pension funds, according to Aon Consulting.
At issue is an accounting rule written into pension funding regulations in 2007 that would overturn existing agreements between companies and pension trustees that allow companies to tap pension surpluses to reclaim cash for corporate coffers. The new rule, which will take effect April 1, 2011, will ban companies from ever taking back pension contributions, even when a plan is in the black.
“It's quite penal on the employer,” said Sarah Abraham, consultant and actuary at Aon. She said a majority of companies have agreements in place with pension trustees that allow for tapping into funding surpluses.
Given that about two-thirds of U.K. pension funds have a deficit, overfunding might not seem like much of a concern. However, a proposed change to the inflation measure used to calculate increases to pension benefits could be a sudden curve ball for companies.
The U.K. government has proposed using the consumer price index to track inflation instead of the retail price index — a move that could improve a plan's funded status by as much as 10 percentage points.
That won't necessarily move plans into funding surpluses. But, on an accounting basis, it could mean that deficit-recovery contribution agreements, which can cover a decade or more, could tip a plan into surplus in the future. And if that surplus can't be recovered, accounting rules require a company to report the full present value of future contributions as a liability on its balance sheet.
A simple example: a company with a £10 million ($16 million) deficit that committed to contribute £15 million next year suddenly sees the deficit reduced to £5 million. Instead of having a balance sheet liability of £5 million or even £10 million, the company has to recognize a £15 million charge.
Aon on Aug 2 reported that strong equity returns and rising corporate bond yields in July combined to bring pension deficits down to the lowest level so far in 2010. The aggregate deficit of the 200 largest U.K. corporate defined benefit pension funds fell 26% in July to £74 billion, down from £100 billion as of June 30, according to Aon's monthly estimate.
Pension trustees can sign a resolution that would continue to allow their sponsors to tap surplus funding, but Ms. Abraham said it's not so simple because trustees are required by law to act in members' best interests.
“Trustees might think, “Why would we give up the right to a surplus?”” she said. That would, in turn, make company officials worry about overfunding and possibly make them stingier when agreeing to contribution levels. “I think it will make negotiations very difficult,” she added.