UK - The number of FTSE350 companies making special additional contributions to their pension schemes has risen for the third year in a row from 58% to 66% in 2008, Mercer Consulting has revealed.

Figures from the Annual Survey of Pension Financial Risk, conducted by Mercer and the Association of Corporate Treasurers (ACT), showed over a quarter of these companies - 27% - were driven to pour more money into the pension as a method of "general risk mitigation".

In addition, 19% of the 89 corporate treasurers surveyed in the research claimed the extra contributions - normally to pay off a deficit - were the result of general pressure from trustees.

Only 8% said the increased contributions were part of an attempt to reduce the Pension Protection Fund (PPF) levy, while other contributing factors to the decision to spend more money on the pension scheme included strengthened mortality assumptions, tax, and the Pension Regulator's (TPR) funding triggers.

The research also revealed another reason employers gave for making the extra contributions is to utilise strong cash flow from operations, as for example in one case the special contribution into a pension scheme related to a deal between the sponsor and trustees over discretionary benefit increases.

However, while the number of firms paying special contributions has risen over the year, the findings revealed the number of respondents having to undertake specific financing arrangements to afford the contributions has almost halved in 2008, from 20% to 11%, the same level as 2006.

Dave Robertson, worldwide partner in the Financial Strategy Group at Mercer, said the results suggested, "some sponsors believe discretionary risk mitigation and improved funding levels add value to the firm".

The survey also revealed 37% of schemes strengthened their mortality assumptions over the year, although the report noted even these revised levels "fell short of the benchmark" proposed by TPR in a consultation on a proposed mortality trigger issued earlier this year. (See earlier IPE article: TPR given power to impose mortality changes on 'imprudent' schemes)

In addition, findings from the research indicated the proportion of schemes using interest and inflation hedging derivatives to mitigate risk is almost unchanged, following a significant increase in 2007, with both nearing 20%, although derivatives for currency hedging was more popular at 25%, while the use of credit protection was "negligible" and none of the respondents had used longevity derivatives.

Mercer highlighted the survey also found only one-third of schemes had reviewed the underlying collateral arrangements between the employer and the fund, despite the market volatility and the face that the use of contingent assets fell in 2008 from 16% to 11%, of which 60% were parent or group company guarantees.

That said, 52% of respondents admitted they would consider further de-risking of the pension schemes if the PPF modifies the risk-based levy formula - currently out for consultation - to take into account investment risk.
Robertson said the lack of review of underlying finance arrangements could be because the deficit is small in absolute terms, or in relation to the size of the sponsor.

"Equally, it may be that the ‘stickiness' of credit ratings has led many trustees to believe there has been no material adverse change in sponsor creditworthiness, despite the evidence presented by bond spreads, credit default swap prices and other market indicators. We would expect all trustee groups to at least consider this, since they are expected to focus on employer covenant throughout the valuation cycle," he warned.

However, Mercer revealed 31% of respondents believe recent pension legislation has had an adverse impact on corporate activity, which rises to 53% when applied to their specific experiences.

In addition, 60% confirmed they would modify benefits, or the funding and investment strategy of the scheme if the proposed changes to pension accounting standards  - including the use of a risk-free rate - are implemented, while 40% said the changes would make them seriously consider buy-out options. 

Robertson said: "There is no single right or wrong level of risk that should be acceptable to a pension scheme and its sponsor. However scheme trustees and sponsors should understand the level of risk that they are running. Once this has been done, they can make informed decisions about whether to modify that level of risk and, if so, how they should do so."

Meanwhile, further research from Mercer - contained in a pension discount liabilities report on the FTSE350 - revealed the global uncertainty in the credit market and the wide range of yields on corporate bonds has led to only a small proportion of companies basing discount rates for pension liabilities solely on the benchmark yield.

Phil Turner, chair of Mercer's global accounting group, said: "The dramatic change in bond yields means it is no longer safe to use an unadjusted index yield for the discount rate."

"It will be interesting to follow this development closely in future years to find out whether the divergence between discount rates and index yields was purely a result of current market conditions or if this is signalling a long term change in methodology," he added.

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