UK: Loose Change

Last Updated: 6 September 2019
Article by John Stittle

There is good news at last for the FTSE pension funds-but is it too late?

It has been another miserable year for many company employees expecting a secure pension in retirement. The trend leading to the extinction of traditional final salary defined benefit schemes shows no signs of abating. Companies are still continuing to close, de-risk and off-load their defined benefit pension fund liabilities. But do recent reports indicate that FTSE100 companies are acting too hastily in closing their pension funds? And are employee members of defined benefit schemes now suffering unnecessarily?

The bleak picture for defined benefit (DB) pension funds continued this spring. John Lewis, the UK retailer, announced the closure of its £6bn DB pension scheme. Rolls Royce then followed and ditched over £4bn of pension liabilities in a complex deal with the insurer Legal and General. Indeed, over the past year, other companies including Marks and Spencer, British Airways, Vodafone and ITV reported that they had also implemented various forms of pension fund 'buy-ins' and transferred pension liabilities to external insurers and finance groups.

There are many factors that have led to the demise of DB schemes over the past two decades – such as political influences, changes in pension fund taxation and the size of pension fund deficits. All these pressures have combined to place financial pressure on both company balance sheets and cash flows. In practice, IAS19, Employee Benefits, has been criticised for requiring sponsoring companies to recognise DB pension fund deficits in their own balance sheets. The Pension Regulator is now also becoming more vigilant in ensuring companies fill financial black holes in their pension schemes with large cash payments over shorter time scales.

Optimistic Note

However, a report issued this spring by international actuaries, LCP has highlighted that the tide of financial fortune may be changing in favour of DB schemes. The actuaries announced that for the first time in 20 years, 2018 'saw the aggregate FTSE 100 pensions accounting surplus [existing] throughout the whole year'. And significantly, this good news for employees continues so far this year too. LCP further point out that since companies have been making 'large contributions and reducing levels of pension risk', the pension benefits of employees are 'now more safer and more likely to be paid than ever before'. These comments are highly significant; they undermine many of the arguments of companies that continue to seek closure of their own DB schemes – or at least those that still remain.

Even more reassuring for these remaining DB pension schemes, IAS19 determines pension fund surpluses on 'a relatively low-risk basis' – with the investment returns of these funds largely expected to be around 1% pa above gilt yields. But, as LCP points out, in practice, modern investment strategies are frequently expected 'to deliver returns significantly more' than the returns usually assumed under the IAS19 rules. The level of these interest rates is important in order to determine the discount rate to be applied in valuing future pension fund liabilities.

Indeed, in practice, there is often considerable variation in these interest rates. Some company pension funds have used discount factors ranging between 2.7%pa and 2.9%pa to determine the present value of pension liabilities.

Life Expectancy

However, there is another important factor that directly impacts on pension fund deficits. For several decades, companies have warned that the lengthening of the life expectancy of pensioners was imposing ever- increasing and unsustainable burdens on pension schemes. Some companies have previously referred to increasing life expectancy as a major justification for their abolition of their final salary DB schemes. But in March this year, the Institute and Faculty of Actuaries announced that its latest Mortality Projections showed that the rate of improvement in life expectancy over the coming decade was expected to be slower than the first decade at the start of this century.

Further evidence from LCP also showed that the number of deaths in England and Wales 'in 2018 was the highest since 1999'. Indeed, these actuaries reported that more companies are now working on the updated assumption that average life expectancies at age 65 for both men and women are now five months lower than those reported in 2017. But LCP sounds a note of cation. The actuaries warn that 'no-one knows whether life expectancies will continue their downward trend' but, if they do, then the potential accounting consequences may be significant.

LCP also highlighted that individual companies also reported considerable differences in assumed life expectancies for their own employees. The median life expectancy in 2018 was 87.5 years but some companies chose to assume expectancies ranging from 85 to around 89 years – a marked variation. This degree of variation implies companies, together with their actuaries and auditors are making their own 'significant judgements' of life expectancy of employees. Indeed, differences of just three years in life expectancy are equivalent to around 10% of gross defined benefit funds reported under IAS19. These differences in assumed life expectancies equate to around £50bn of gross liabilities for FTSE100 companies. As such, in effect, around £50bn is being based on 'subjectivity' and 'decided by company directors for company accounts'.

Pulled Both Ways

Although the assumptions made about reduced life expectancies and increased discount factors combine to improve the net surplus of pension funds there are 'tensions' that may potentially counter the impact of these positive changes. As a result, LCP state that companies may find themselves 'being pulled in opposite directions'. The report identifies increased pressure from The Pension Regulator to ensure companies improve the financial health of their pension funds at a faster rate and to 'mend the roof while the sun is shining'. Other pressures have come from the FRC which has already found that improvements are required in the audit of IAS19 issues.

Accounting Rules

However, there still lurks a potential change in accounting regulation that may potentially increase pension deficits in the coming years. For the Iast five years, the IASB's International Financial Reporting Interpretation Committee (IFRIC) has been considering changes to tighten the deficit reporting rules. Although earlier plans were ditched – revised proposals in IFRIC14 are now under formulation. These revised proposals may mean some FTSE100 companies will have to recognise additional liabilities in excess of the IAS19 requirements, based on potentially extra pension fund contributions that a sponsoring company may have to contractually pay in the future. But this extra contribution is often based on how a pension scheme trust deed has been legally constructed.

Wider Perspective

Although LCP only reviewed FTSE100 companies, another report from PwC/Skyval examined the overall financial health of all of the UK 5,450 company defined benefit pension funds. Nationally, the financial health of these DB schemes showed an improvement, but, overall, there still existed a substantial aggregate deficit. PwC found that the total DB deficits were £230bn in November 2018, but significantly falling to £180bn in April 2019. Steven Dicker, PwC's chief actuary, admitted that these pension funds were recently benefiting from an upward trend in both equities and in bond yields and from the slowing down of life expectancy improvements. Nevertheless, there is a clear distinction between the improving state of FTSE100 company pension funds and the on-going deficits of the majority of smaller and medium sized companies.

Extinction

It is important to place into context the dramatic reduction in providing final salary DB schemes that has already taken place. Currently, only two FTSE100 companies, Croda and Johnson Matthey, offer DB schemes to new employees. Increasingly, even existing staff are being affected – with only 41% of these FTSE companies now offering DB to existing employees. Other remaining FTSE100 companies are also increasingly taking steps to de-risk their DB pension schemes – if they are still operating this type of provision for employees. Many pension schemes have reduced their holdings in more risker equity investments in favour of less volatile investments.

In the past two decades, it appears that many FTSE100 companies may have taken an unnecessarily over-pessimistic and too short term-ist view about the future of DB schemes – and have rashly closed them. The tide may now be turning and DB schemes may actually prove to be a financially viable form of compensation benefits for all levels of employees. Even so, smaller companies are still facing problems. But for most employees, the more favourable recent data for pension funds has probably come too late. Since the corporate fashion has been to de-risk and abolish DB pensions, it is unlikely that these schemes will be re-introduced.

John Stittle is a Senior Lecturer at the University of Essex

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions