A doubling of pension deficits caused by the turmoil in the financial markets is casting cloud of uncertainty over funding negotiations says Towers Watson.
Funding negotiations between employers and pension scheme trustees are becoming less predictable says the consultancy, potentially leading to significantly higher contributions from companies or longer anticipated deficit repayment periods, depending on how stakeholders react.
The pension deficits that FTSE350 companies have to disclose in their annual reports have increased at an average rate of more than £2bn a day at the beginning of the month, with the aggregate deficit increasing by £21bn in the first 10 days of August – from £52bn at the end of July to £73bn when markets closed on 10 August. Stocks have regained some ground since then, but are a long way short of pre-summer levels.
There is also scope for trustees’ and employers’ negotiating positions to diverge, leading to more difficulty in reaching agreement, warns the consultancy.Towers Watson estimates that for a scheme whose assets were 90 per cent of its liabilities on 31 March 2011, the funding level determined on the same assumptions may only be 80 per cent today if two-thirds of its assets were in equities. If changes to equity prices and gilt yields since March are taken into account, this could double the contributions required to pay off the deficit within any particular period of time.
John Ball, head of UK pensions at Towers Watson says: “To repair a bigger deficit, trustees need increased contributions from the employer or higher investment returns from their assets. If they can’t expect either of those things, the deficit must be paid off over a longer period, with members’ benefits less secure in the meantime.
“Most schemes are relying on higher investment returns from equities to do some of the heavy lifting when it comes to getting back in the black, and have significant exposure to market volatility as a result. An important question for trustees and companies is: do they view recent events just as an example of that volatility or do they believe that something fundamental has changed which means they must anticipate lower investment returns between the valuation date and the time when benefits are paid out? If the former, they need to hang on for the ride which is likely to continue to be bumpy; if the latter, they need to consider what action they should be taking.
“Scheme funding agreements based on March 2011 valuations do not have to be finalised until next June, so we expect that trustees and employers will watch how things evolve over the coming weeks and months before nailing down their plans. For now, market volatility has cast a cloud of uncertainty over the agreements that will be reached on scheme funding.”