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Article | Pensions Briefing

Pensions accounting: surpluses on the horizon?

Findings from our FTSE 350 Defined Benefit (DB) Pension Scheme Survey 2018

Pensions Corporate Consulting|Pension Board and Trustee Consulting
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By Charles Rodgers and Stef Neylon | November 14, 2018

Stef Neylon and Charles Rodgers take a look at some of the key findings from our FTSE 350 DB Pension Scheme Survey 2018.

Stef Neylon and Charles Rodgers reflect on the results of our seventh annual FTSE 350 DB Pension Scheme Survey, which investigates the impact of defined benefit pensions on company accounts as at 31 December 2017. They take a look at funding level improvements seen in 2017 and at the start of 2018, along with some of the current issues in pensions that are highlighted by the report.

Improving funding positions

90% of companies showed an improvement in their funding position over the year, and just over 35% disclosed a surplus

Following an increase in deficits in recent years, 2017 somewhat bucked the trend, with the aggregate FTSE 350 pension deficit falling by £40 billion to an end of year deficit of around £35 billion. Of those reporting at 31 December 2017 with defined benefit pension schemes, around 90% of companies showed an improvement in their funding position over the year, and just over 35% disclosed a surplus in their accounts.

Over the year, typical investment strategies returned around 5%, whilst liabilities fell slightly due to companies adopting a combination of the latest mortality projections and alternative discount rate models.

Since the start of 2018, positions have improved even further, with rising real corporate bond yields in particular helping to reduce the aggregate FTSE 350 pension deficit to be consistently less than £10 billion over the last few months.

Graph: Aggregate FTSE 350 pension deficit
Figure 1. Aggregate FTSE 350 pension deficit

Source: FTSE 350 DB Pension Scheme Survey 2018

Alternative discount rate models

With the background of a continuing low-yield environment, a number of companies took a closer look at the method used to set their discount rate assumptions.  Any discount rate model has an element of judgement in terms of which bonds are appropriate to include, and how to extrapolate the derived corporate bond yield curve to durations longer than available in the corporate bond data.

Changes to the discount rate model would have resulted in discount rates that were around 35bps higher, potentially reducing liabilities by around 7%

For example, some companies have excluded university bonds from the corporate bond universe, and others have extrapolated the yield curve based on a flat curve at longer durations rather than following the shape of the gilt curve.  As at 31 December 2017, changes to the discount rate model would have resulted in discount rates that were around 35bps higher, potentially reducing liabilities by around 7%.  Five companies explicitly referenced a change to their discount rate model compared with the prior year, but our analysis of the data suggests up to 45% of companies may have made some amendments to their method.

The impact of pensions flexibilities

The increase in benefit payments has removed an additional £20 billion of FTSE 350 pension obligations

With members of DB schemes potentially able to access the pension flexibilities which came into effect on 6 April 2015 by transferring to a defined contribution (DC) arrangement, we have seen an increase in the amount of benefit payments made by FTSE 350 companies, driven by increased transfer value activity.  Around half of the companies reporting at 31 December 2017 have seen their benefit payments increase by more than 25% compared to the year before.  The increase in benefit payments has removed an additional £20 billion of FTSE 350 pension obligations. 

Graph: Change in benefit payments relative to previous year
Figure 2. Change in benefit payments relative to previous year

Source: FTSE 350 DB Pension Scheme Survey 2018

Looking towards the end game

With improving funding positions, and additional liabilities being removed through members taking transfer values, the logical next step for companies is to consider how close they are to  being fully funded and what to do when that target has been achieved.

Of the companies that explicitly disclose recovery plan details, we have seen that a third are due to pay no further deficit reduction contributions over 2018.  In accounting terms, just over 35% of the companies reporting at 31 December 2017 were already in surplus, and 80% of the companies whom disclosed a scheme deficit could clear this with payments equivalent to less than two years’ worth of dividend payments.

Graph: Years of dividend payments to pay off accounting deficit
Figure 3. Years of dividend payments to pay off accounting deficit

Source: FTSE 350 DB Pension Scheme Survey 2018

Whilst many companies are planning to run off their DB pension schemes for the foreseeable future, for many others the aspiration is to transfer all of their DB pension risk to an insurer (called a buy-out). We estimate that around 10% of companies already have over 90% of the assets required to do this once allowing for the additional cost of securing liabilities with an insurer (compared to the defined benefit obligation calculated on an accounting basis)..

For the majority of the companies that are close to being able to buy-out, the shortfall is such that it is equivalent to only one or two years’ worth of dividend payments, and so if they wished to do so they could bridge the gap relatively quickly. This suggests that the pipeline of companies that will realistically be in a position to carry out buy-out transactions in the next few years is strong and potentially in excess of current market capacity.

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