FTSE 100 pensions: Plus ça change …
LCP's Nick Bunch examines the changing trends captured over the last 20 years for FTSE 100 DB pensions.
As FTSE 100 companies' pension liabilities approach £500bn (€581bn) and the UK's largest employers embrace auto-enrolment, the closure of final salary schemes to future accrual is gathering pace. Some 39 FTSE 100 companies now only offer defined contribution (DC) pensions – a figure that stood at just two in 1996 when BSkyB and Foreign & Colonial were the only ones to differ from the norm. During 2012, seven companies either closed or proposed closing their schemes to future accrual (including FTSE 100 stalwarts HSBC and Kingfisher), which follows a trend begun in 2005 by Rentokil. This now leaves only 61 FTSE 100 companies with defined benefit (DB) schemes open to future accrual, and the number is expected to fall further as companies review their options when contracting-out ceases in 2016.
The total pension deficit for FTSE 100 companies remains broadly unchanged at £43bn – an overall level of cover of 91% – compared with £42bn last year. This is despite good investment returns and an increase in company pension contributions from £21.4bn in 2011 to £21.9bn in 2012. We estimate that, of these contributions, around half went towards removing deficits rather than towards additional pension benefits for current employees.
One of the features of the past year has been continuing legislative and regulatory changes. The major initiative has, of course, been the re-introduction of auto-enrolment from October 2012, which now applies to the majority of the FTSE 100. Beyond that, however, the introduction of a flat rate state pension and the end of contracting out from 2016 are policies from which we are yet to see the repercussions.
Last year saw a slight move back into equities, driven by the slow but noticeable improvement in the global economic picture and bond yields looking consequently less attractive. Asset holdings in equities grew to 36.4% from 34.8% last year, although this is still a large reduction from the figure of nearly 70% seen around the turn of the millennium. Over the longer term, we expect schemes to continue to move out of equities as they mature further and look to de-risk their investment strategies.
Interestingly, the last few years have seen an increase in companies seeking alternatives to cash funding – with some looking to everything from cheese (Dairy Crest) and whisky (Diageo) to aircraft (International Airlines Group), while others grant their schemes a charge over assets such as power stations (Centrica), hotels (Intercontinental Hotels Group) and machinery (Rexam).
So what has changed since our first report in 1994? First, that survey showed an average funding level of 120%. In fact, the worst-funded scheme in the FTSE 100 was still 88% funded, and the highest funding level was 183%. This meant many companies were able to take pension contribution 'holidays'. Compare that with this year's report, where just 14 companies disclosed a surplus in their 2012 accounts.
Perhaps unsurprisingly, allowance for life expectancies has increased dramatically. In the last eight years alone, companies have assumed their pension scheme members will live for a further three years – with a male aged 65 assumed to live for 22.8 years in 2012 compared with 19.8 years in 2005. This has added around £40bn to pension liabilities for the FTSE 100 – a figure that compares closely with the current deficit.
Some things never change though, with successive chancellors seeing the tax relief available to pension schemes as any easy source of revenue. In the 1990s, Norman Lamont and Gordon Brown eroded, and then abolished, the tax relief on UK equity dividends pension schemes previously enjoyed. More recently, we've seen reductions in the Lifetime Allowance and the Annual Allowance, ostensibly aimed at reducing the amount on which high earners are able to draw. All of these changes have come at the expense of ordinary pension scheme members, with the most recent changes likely to impact those on moderate earnings as well as high earners.
One trend we are glad to see continue, however, is the increased transparency and clarity of disclosure of companies' pensions obligations. This is something LCP has called for since 1994, when disclosures frequently left the reader with no real understanding of a company's arrangements and the resulting risks. This is not to say there isn't still work to be done, and we will certainly continue to press companies on their disclosure, which is, after all, to the benefit of all those who invest in these companies through their retirement savings.
The 20th annual LCP Accounting for Pensions report comprises detailed research of pensions disclosures by FTSE 100 companies. A total of 14 companies were excluded from the report in 2013, as they do not sponsor material funded defined benefit schemes. Nick Bunch is a partner at LCP, a member of its scheme funding group and co-author of the report.