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Special Report

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Hit by deficits

Poorly performing stock markets have pushed the total deficit in UK company schemes, under the FRS17 accounting standard, to an estimated £70bn (e111bn). These figures were recently released by Watson Wyatt and UBS Warburg, which estimate that nine out of 10 UK company schemes are now in deficit.
One of the worst-affected schemes under the FRS17 standards has been Rolls Royce, with a deficit of £1.1bn, representing 50% of its market value. Other big names, such as BT, Royal & Sun Alliance, British Airways and J Sainsbury, have also been hit.
All these pension schemes have suffered from having a high exposure to equities. According to Watson Wyatt/UBS Warburg, the average equity allocation of UK company schemes is around 65% of total assets, with only around one in 10 having less than 50% of their assets invested in stocks.
Another report by Hewitt, Bacon & Woodrow suggests that the average funding level of UK pension funds, as revealed under FRS17, is likely to have fallen to 87% since the beginning of the year, from the 100% funding level recorded at the end of 2001. Unless the equity markets improve dramatically this level could fall further.
The latest figures on local authority pension funds have also been disappointing. According to the WM Company these funds registered a second consecutive year of negative returns. The poor performance of the schemes, with combined assets of £85bn, has taken three-year performance to 2% and below the level of inflation. This is quite significant, taking into account that these defined benefit (DB) plans cannot close their schemes to new members, an approach that has been taken by many companies to reduce costs. This financial pressure has been translated into many local authority pension funds switching to passive investment, and abandoning UK equities in favour of international stocks. The WM Company estimates that around £2bn of assets that local authorities were investing in UK equities has now gone abroad.
More disappointing news arrived from the pooled pension fund sector, which for the year to 30 June returned a median of –12%.
All these figures regarding the different sectors of the UK pension fund industry have obviously been translated into serious concerns among pension funds sponsors and scheme members, but also among politicians and regulators that made public the need for a review of the whole system.
First there were the Pickering and Sandler reviews. Pickering argued that pensions needed to be made simpler, asking the government to re-introduce compulsory company scheme membership and to reduce the range of pension products available from more than 20 to just three or four. Pickering also called on the government to draft a new pensions act that would consolidate any existing private pensions legislation
These proposals were welcomed by pension funds, as a survey published in August by the National Association of Pension Funds (NAPF) shows. Seventy two per cent of the participants in the survey – around 100 UK pension funds – found that the report’s proposals, if implemented, would lead to a simplification of the pensions framework.
However, 75% said that the Pickering proposals do not go far enough in addressing the problems facing the industry.
On the other hand, Sandler’s report recommends investors to increase the use of index tracker funds and to switch from active to passive management to cut costs. Also it acknowledges that the various pensions tax regimes need urgent consolidation and asks the government to make retail savings products more easily available.
Those who thought that the review season was over after these two reports were surprised to see how only a fortnight later in July the House of Commons work and pensions committee announced a wide-ranging enquiry into the future of saving for retirement in the UK, so more recommendations will soon be released.
Some might think that so many reports and reviews of the market in such as short period mean that the system’s health needs urgent treatment, but many believe that the reason is that industry is reaching a new stage of maturity and needs new solutions and strategies from those used in the past.
When, a year ago, the Boots pension fund announced it was selling its entire equity and short-term bond investments in favour of bonds, there was panic in the market about other funds following these steps. But the Boots case was scheme-specific and no other similar moves away from equities have been registered.
What is true is that trustees are more focused on their funds’ liabilities and more trusting the advice of investment consultants.
First it was FRS17, the Myners review and the Unilever/Merrill Lynch case that kept consultants busy for months answering questions from clients regarding ways of measuring performance and accountability. However, all these issues have certainly increased the investment awareness of fund sponsors, which are now better prepared to face the changes in the industry. The move to defined contribution (DC) systems is also making possible that this awareness reach scheme members and the level of education in issues related to pensions has improved considerably.
The government is expected to make public a green paper some time this autumn reviewing all the issues under debate among professionals.

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