Discount Rates and Longevity Offset Pension Cash Injections (Again)

Corporate pension funds have been pouring additional contributions into a big, black hole, consultants have revealed.

(October 1, 2012) — Liability increases – due to demographic and economic changes – have once again meant extra contributions made to corporate defined benefit pension funds in the United Kingdom have failed to make a dent in deficits.

The largest 100 companies in the UK increased their longevity assumptions for the sixth straight year, according to Investment Consultant Mercer, which has added around 1% to their pension fund liabilities over the 12 months.

On a £100 million fund, longer life spans for active and retired members would have meant £7 million was added to liabilities over the past six years, even if no other changes were made to the obligations.

Unfortunately for company bosses, however, discount rates have also been falling, meaning liabilities have ballooned even further – and at a much more dramatic rate than increases due to longevity.

Mercer said that for each 1% fall in discount rate, the liabilities for a typical fund would increase by around 20% -25%. This is because a small change compounded over 20-25 years – the average time when benefits are paid out by pension schemes – can be substantial. The fall in discount rates for corporations operating these funds in 2011 continues the recent trend, according to Mercer. The median discount rate has fallen each December 31 from 5.7% a year in 2009 to 4.8% a year in 2011.

Warren Singer, principal at Mercer, said: “While the impact of increasing discount rates has been mitigated to some extent by falling inflation expectations, the very significant falls in the discount rate highlight the challenges facing UK companies with DB pension promises. During 2011 FTSE350 companies made an estimated £25 billion of contributions but still watched their deficits grow.”

Over the past 12 years, these companies have made £175 billion in pension contributions, Mercer said, yet due to market movements and liabilities increasing, most are at the same funding level as they were in 2000.