FTSE 350 pension deficit hovers around £10 billion mark

12 September 2018 Authored by Consultancy.uk

In recent years challenging market conditions and an ageing population have seen some schemes run increasingly large deficits. New reporting into the segment shows that most pension schemes are relatively well positioned going forward, however, with the aggregate deficit having fallen from £75 billion to £35 billion by the turn of the year, with a further improvement in 2018.

As the population ages in the UK, more and more people are set to draw on retirement plans and programmes. Concerns are mounting however, around the sustainability of some of the pension schemes, as the population not only ages but life expectancy has significantly increased. New analysis from the largest pension and actuarial consulting firm in the UK explores some of the trends in 102 Defined Benefit (DB) FTSE 350 run pension schemes, representing around 70% of all schemes by value.

According to the report from Willis Towers Watson, one of the driving factors for budget difficulties for pension schemes in recent years has been the increasing average age of the UK population. However, recent analysis shows that life expectancy for those whom reached 65 has actually decreased slightly, from 87.7 for men and 89.6 years for women in 2016 to 87.6 and 89.4 respectively in 2017. This slight decline in demands on pension pay-outs was accompanied to changes to how discount rate models are calculated, resulting in a pension deficit decline among the FTSE 350 of £40 billion by Christmas 2017.

Distribution of funding levelJust 18% of the companies in the FTSE 350 index were meanwhile reporting funding levels below 80% of scheme assets, while around 16% of companies had funding levels at between 80-90% of assets. 30% were at funding levels between 90-100%. On top of this, around 36% of companies were running a surplus, according to Willis Towers Watson’s latest survey.

Asset returns were slightly more volatile in 2017 relative to 2016. In the latter, strong bull runs in both UK and overseas equity markets, as well as stable returns in the bond markets, saw yearly returns top 20%. In 2017, periods of rocky returns saw 5% average growth booked for the year. For 2018 the bullish market has returned, has picked up again, even in light of global geopolitical uncertainty. Overall the study shows that investment returns on average outstripped growth in liabilities over the period.

Asset returns

Elsewhere, defined benefit obligations (DBO), the estimated cost of paying out a promised benefit, against the market capitalisation, gives a relatively good indication of the risk faced by companies from their pension obligations. The higher the DBO relative to the market capitalisation of a company, the more likely a company is to record pensions as a key risk.

For instance, in companies where DBOs stand at 0-25% of market capitalisation, 22% record pensions as a key risk, while companies with liabilities at 25-50%, 45% say there is a key risk. The biggest risk noted however, is at companies with liabilities at 75-100% of capitalisation, with 83% citing key risks. Companies with DBOs above 100% are slightly less concerned, with 70% citing key risk from pension obligations. Overall however, only 35% of companies on the FTSE350 noted pensions as a key risk.

Companies disclosing pensions as key risks

In recent years, companies have in recent years begun to de-risk their pension asset allocations, shifting away from equities and into bonds. In 2013 equities stood at around 40% of total pension allocation, by 2017, this had fallen to around 25%. Bonds took on a larger share of the pie, while property and alternatives remained relatively stable, with the latter increasing slightly on 2013. The report adds that this shift has seen the deficits of many FTSE 350 companies pushed further down, with corporate bond yields helping the aggregate deficit to sink to around the £10 billion mark as of May and June 2018.

A quarter of companies have bought bulk annuity insurance cover, up from 20% last year – with companies increasingly seeking to de-risk their pension funds as a wide range of market uncertainties approach at a time of large scale demographic changes. The shift was noted in particular for companies with large DBOs relative to their market capitalisations.

FTSE 350 companies’ contributions

Companies have also increased their relative contributions to schemes over the past three years. In 2015 around £14 billion was contributed, with the largest part consisting of the cost of accrual stood at £4.9 billion, followed by DC contributions at £4.8 billion and deficit reduction contributions of £3.7 billion. However, by 2017 deficit reduction contributions almost doubled to £5.8 billion, while cost of accrual saw a slight decline to £4.6 billion, with DC contributions climbing by £400 million.

Commenting on the changes in pensions schemes for 2017 among FTSE 350 companies, authors Charles Rodgers, Alex Browning and Claire Kelly concluded, “After a significant increase in defined benefit (DB) pension scheme deficits in 2016, funding levels were relatively stable throughout 2017, and by the end of the year the aggregate deficit of FTSE 350 companies had actually fallen by around £40 billion. This improvement in the position is in part due to the effect of companies adopting the latest mortality projections and making changes in the discount rate models they use to value their pension liabilities.”

Related: Pension funding across top 22 markets hits $41 trillion.

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