(January 4, 2012) — Mercer’s latest study on scheme deficits in the United Kingdom shows that pension accounting deficits have ballooned to £84 billion at December 31, 2011 compared to £64 billion at December 31, 2010.
The findings are revealed in Mercer’s Pensions Risk Survey, which shows that the rise in pension deficits represents a 3% fall in funding levels over the year from 88% to 85%. The spike in deficits, the consulting firm says, has been spurred by relative confidence in UK corporate debt. “At the start of 2011 the yield on Sterling AA rated corporate bonds was nearly 1% per annum higher than the corresponding Eurobonds, whereas at the year-end the yields were virtually identical,” said Ali Tayyebi, Senior Partner and Pension Risk Group Leader, in a statement. “As the European sovereign debt crisis intensified in the autumn, UK government bonds became a relative safe haven. It looks like this back-handed compliment has now extended to UK corporates as well over the last couple of months. The flip side of this is that it has increased the notional cost of the debt owed to their own DB pension schemes and means that 2011 ends on a bleak note despite asset values showing an increase over the year, and long term inflation expectations being much lower now than they were at the start of the year.”
Corporate bond yields, which are used to discount liabilities, dropped again over the month, thereby increasing liability values, Mercer says. Adrian Hartshorn, Partner in Mercer’s Financial Strategy Group adds: “2011 was a defining year with a clear bifurcation taking place amongst schemes. Companies and trustees that have taken action to hedge liability risks have seen their deficits hold steady or increase only moderately. However, companies or trustees who have not hedged liability risks have been more adversely affected. Looking forward into 2012, managing liability risk will continue to be an important focus for many organizations and we expect to see the implementation of both traditional and non-traditional risk management strategies including interest rate and inflation hedging, longevity hedging, liability management exercises or the use of non-cash funding options to smooth cash contribution requirements.”
Mercer’s data follows recent data compiled by the Pension Protection Fund (PPF), which showed last month that the collective deficit of private sector final-salary pension schemes hit a new record of £222 billion in November. Another report by consulting firm Lane Clark & Peacock (LCP) — released in November — showed that accounting changes and Solvency II are tremendous threats to pension plans in 2012.
Despite record levels of contributions, LCP’s analysis noted that combined scheme deficits of FTSE100 global firms have grown by 70% in 12 months to £248 billion. “The year ahead looks like it may well bring one burden too many for European pension schemes. Pressure to deal with new pensions accounting under IAS19, volatile markets and regulatory uncertainty are likely to lead to further pressure for organizations to reform pension plans in every one of the many countries where our clients operate,” noted Alex Waite, partner and head of LCP Corporate Consulting. “Going into 2011 the world’s largest 100 companies disclosed pension deficits of €170 billion. To put that in perspective, it’s equivalent to the cost of the Greek bailout. And as 2011 has proved, just because it’s bad at the start of the year, doesn’t mean it can’t get worse. In last year’s European Pensions Briefing we estimated that a one-in-ten-chance outturn could increase deficits by €100 billion or more. In fact, over the year so far, the combined deficit has increased by over €120 billion.”
The dismal reality among schemes in the UK comes as a survey conducted by the Association of Consulting Actuaries (ACA) shows that with five million public sector employees being offered pensions ‘far better than people in the private sector,’ the gulf between private and public sector pensions is set to grow amid a tough economic climate. According to ACA, nine out of ten private sector defined benefit schemes are now closed to new entrants and four out of ten closed to future accrual (half of these closing in the last year alone).
Commenting on the survey results, ACA Chairman, Stuart Southall said: “Set against this, the Government is at last waking up to the reality of how low morale is in the private sector pensions world and we understand it is looking to produce a paper in the New Year examining how workplace pensions can be ‘reinvigorated’. The preparedness of some employers to share risks, echoed by our survey, and the endorsement of this approach by the recent Workplace Retirement Income Commission, needs to be followed up with some urgency as part of this reinvigoration agenda.”