FTSE 100 deficit hits £41bn
UK - Market volatility has caused the UK pension schemes of FTSE 100 companies to suffer a "severe swing" in funding level from a £12bn (€16bn) surplus to a £41bn deficit over the last 12 months, according to Lane Clark & Peacock (LCP).
The firm's annual report 'Accounting for Pensions 2008' also suggests at least three FTSE 100 companies could have bought out their pension schemes without the need for additional contributions.
However, by mid-July 2008 LCP warned deteriorating market conditions meant no FTSE 100 company was in a position to pursue a buyout without additional costs, which the firm suggested could highlight "a possible governance gap" in relation to the speed of decision-making.
The report confirmed companies and pension funds have suffered from the extreme volatility in markets over the last year, as the aggregate position of FTSE 100 UK pension schemes ranged from a £19bn surplus in November 2007 to a £41bn deficit in July 2008.
That said, LCP claimed the requirement of the IAS19 accounting standard to value liabilities using 'high quality' corporate bond yields has had a "cushioning" effect, as it estimated rising bond yields since January 2008 reduced pension liabilities by £40bn - which it claimed was "enough to offset almost half of the huge losses arising from equity market falls and rising inflation".
The research also showed 14 of 23 companies reporting their accounts in March 2008 disclosed an aggregate surplus of £5.9bn, however the firm said "in light of the subsequent fall in bond yields, equity market falls and increasing fears over inflation", it estimated the 14 companies suffered losses of almost £13bn between March and July 2008, resulting in a total deficit of £7bn.
The report noted as a result of the "brutal" financial conditions over the last year, there is "some evidence" of FTSE 100 firms taking action to address pension risks through changes to asset allocation strategies, as overall the 90 defined benefit pension schemes analysed reduced their equity allocation from 59% in 2006 to 53% in 2007.
However, while LCP claimed this was a "notable reduction" it pointed out the impact on market-related pension risks is "relatively slight" and estimated there is a 10% chance that falling markets alone could cause further losses of £45bn in the next 12 months.
The report also warned trustee control over asset allocation could create challenges for companies, as they may be more cautious in the strategies they adopt, and this could prevent schemes benefiting from market opportunities as they arise.
Bob Scott, partner at LCP, said: "Some companies chose to spend their surpluses on various forms of de-risking activity including buyout, purchasing financial swaps and reducing their exposure to equities.
"Events of the last year demonstrate the importance of assessing and managing pension risks and being prepared to take opportunities when they present themselves," he added.
LCP also highlighted the impact of increases in life expectancy as the report showed FTSE 100 schemes again adjusted assumptions upwards in 2007 to reflect the latest findings, so the average life expectancy for a UK male is now 85.5 years, up from 84.8 in 2006.
As each additional year of life expectancy increases the total FTSE 100 pension deficit by £11bn, LCP estimates increases in assumed life expectancy has already added £9bn to the FTSE 100 deficits between 2006 and 2007.
The LCP report also highlighted the position of international pension funds in the FTSE Global 100 Index, which reported net pension deficits of £18bn in 2007, compared to £58bn in 2006.
The report attributed the reduction in overall liabilities to increases in corporate bond yields, however it warned falls in asset values in 2008 meant by mid-July the deficit of the FTSE Global 100 Index had increased to £30bn, as falls in the equity market reduced asset values by £40bn.
Even though LCP admitted a number of companies, particularly in the US, had reduced equity allocations, overall 50% of assets were invested in equities, leading LCP to suggest there is a 10% chance that the FTSE Global 100 Index could lose £80bn in the next 12 months.
Meanwhile, research by Mercer into the funding level of pension schemes belonging to FTSE 350 companies revealed a total deficit of £47bn at June 30, 2008.
Mercer's quarterly pensions report revealed economic conditions wiped an estimated £61bn from FTSE 350 pension schemes, from a surplus of £14bn at March 31 2008, and bringing the average funding level down from 103% to just 90%.
In addition, the firm claimed while the estimated risk of default for a median FTSE 100 company is unchanged, the default risk of the 10% of companies most exposed to pension liabilities has quadrupled, suggesting employer covenants might have "weakened significantly".
Deborah Cooper, head of the retirement resource group at Mercer, said: "Though companies might not want, or be able, to buy out the liabilities, there are other alternatives that can be effective in reducing balance sheet volatility. Trustees should be prepared to consider these seriously, given how turbulent financial markets have been.
"They also need to be extra vigilant in keeping track not only of their pension scheme finances, but also the finances and covenant of their supporting companies," she added.
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