News

Pensions Watch – July 2011

Deficits still giving sponsors a headache
Analysis conducted by consultant Barnett Waddingham and the Centre for Global Finance at the University of the West of England found that 29 of the UK’s largest 350 companies (FTSE 350) which sponsor defined benefit (DB) schemes are making deficit recovery repayments that exceed the cash flow they generate as businesses.  Not only is the relative size of deficit repayments to cash flow impacting the ability of “a significant number of companies” to raise finance but, as the study points out, 70 sponsors are now paying more to plug DB deficits than they are to fund the benefits accrued by current employees.  Additionally, around 25 per cent of FTSE 350 DB schemes have liabilities that exceed the sponsoring company’s market capitalisation.

Separately, buyout specialist, the Pension Insurance Corporation, cautioned that a sovereign default in the eurozone could cause DB deficits to increase by 45 per cent on the assumption that equity markets would drop by 20 per cent and gilt yields would fall by 0.3 per cent.However, on a more positive note, consultant Aon Hewitt, which puts the collective FTSE 350 IAS 19 deficit for June at £44bn, believes that, all else equal, a collective surplus could result by the year end. 

However, this is contingent on those schemes affected by the switch from the RPI to the CPI basis of revaluation and/or indexation making the assumption that the annual CPI number will be 0.7 per cent lower than the RPI, rather than the 0.5 per cent difference most are currently assuming.     

Public sector deficits widen
The Treasury revealed that unfunded public sector pension liabilities now stand at £1,133bn, or 78.7 per cent of GDP, up from £770bn in 2008, largely as a result of the recent imposition of a lower, more realistic discount rate being applied to their valuation.

Separately, the Institute of Economic Affairs estimates that current state pension scheme liabilities similarly stand at £1.1tn, while putting the cost of future liabilities at £1.7tn, with the independent Office for Budgetary Responsibility (OBR) warning that the cost of providing state pensions will rise from 5.5 per cent of GDP today to 7.9 per cent of GDP by 2060, driven by a rapidly ageing population and state pension increases being linked to earnings plus 0.2 per cent.

All of this comes against the backdrop of the OBR forecasting dramatic increases in future state healthcare spending from 7.4 per cent of GDP to 9.8 per cent in 2060-61 and social care costs rising from 1.2 per cent to two per cent of GDP over the same period, offset to a degree by the planned cuts in the cost of public sector pension provision from two per cent to 1.4 per cent of GDP.

Line drawn in the sand for public pensions
Danny Alexander, Chief Secretary to the Treasury, has reiterated the government's commitment to increasing the contributions made by public sector employees to unfunded public sector pension schemes by an average of 3.2 per cent by 2014-15, starting next April.

The highest earners will take the brunt of the proposed increases, with senior NHS consultants and family doctors prospectively facing contributions of 14.5 per cent of salary and senior police and fire officers being potentially subject to an eye watering 17 per cent contribution rate, though the uniformed services, unlike most others in the public sector, will continue to take their pensions from age 60.  The armed forces and those earning below £15,000 will be exempt from the increases, though a 1.5 per cent hike in contributions is in prospect for those public servants earning less than £21,000.  These contribution increases will, of course, be implemented against the backdrop of RPI indexation for pensions in payment having recently been replaced by CPI increases and immediately prior to the further dilution of pension benefits as normal retirement ages are increased and final salary makes way for the imposition of career average revalued earnings in 2015.

Meanwhile, the funded local government pension schemes (LGPS) will not be subject to the planned contribution increases on the premise that LGPS will formulate its own package of cost cutting reforms to meet with the Treasury’s targeted savings of £1.8bn for public sector pension scheme provision by 2015.

While the government will continue to conduct separate negotiations with each scheme and with the unions, it would appear that the government has made up its mind over the quantum and timing of the contribution increases for unfunded public sector schemes and will dig its heals in as it prepares to set an annual ceiling for the cost of public sector pensions to the taxpayer, this autumn.  Let's hope that both sides remain pragmatic if we are to avoid a late-1970s winter of discontent.  That said, with union power today being a pale shadow of what it was 33 years ago, perhaps Danny Alexander has more to fear from health secretary Andrew Lansley, who attacked the reforms, singling out the impact on women working in the NHS in particular, as “inappropriate”, “unrealistic” and failing to meet the coalition’s “commitment to maintain gold standard pensions”.

CPI index-linked gilts consultation
With the move from the RPI measure of inflation to that of CPI determining the minimum rate at which 68 per cent of occupational DB schemes revalue their deferred pension rights and 22 per cent index their pensions in payment (source: DWP - based on scheme membership numbers), the Debt Management Office (DMO) has issued a consultation paper which seeks to establish the potential demand, particularly from pension funds and insurance companies, for the issuance of CPI-linked gilts.  In addition, the DMO is keen to determine the extent to which the demand for and liquidity of RPI-linked gilts might be affected and to gauge the reaction to the possible introduction of a new CPI-H index, against which the gilts might be linked, that would, unlike the incumbent CPI measure of inflation, include housing costs.  The consultation ends on 22 September. 

Spotlight on auto-enrolment
Despite only 14 months to go to the October 2012 implementation of auto-enrolment,  consultant Hymans Robertson found that nearly one fifth of the UK’s largest employers (those with 5,000+ employees) have yet to decide on the type of defined contribution (DC) scheme into which they will auto-enrol their eligible employees.  Meanwhile, 30 per cent of large employers are planning to enrol their employees into their existing trust-based defined contribution (DC) schemes rather than contract-based bundled schemes (which provide both investment management and third party administration) that are both cheaper to administer and better able to cope with dramatic increases in scheme membership. 

Separately, the Pensions Regulator looks set to increase the disclosure requirements for DC scheme costs and charges ahead of auto-enrolment when publishing its detailed findings and conclusions on the future of DC pension provision in the autumn.

And finally…

Could do better
School may be out for the summer but according to the Mercer Global Pensions Index, which compares the retirement provision systems of 14 countries, the UK could do better, with major risks and shortcomings that need to be addressed having been identified by the consultant.  Ranked on a scale between zero and 100, while no country received a score above 80, the UK, with the world’s third largest pensions market, had to settle for a score in the 50 to 65 band, trailing the class leaders Netherlands, Switzerland, Sweden, Australia and Canada by a considerable margin.   

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