In June 2009, the combined deficit of
defined benefit pension schemes sponsored by UK companies stood at
£40bn ($60bn). A year on and it has soared to a new record high of
£100bn and could get far worse before it gets better, warns
consultancy Aon Consulting.
Sparking fears of a further deterioration was
the Emergency Budget, delivered on 22 June by Chancellor of the
Exchequer George Osborne. Aon believes that fiscal measures
introduced by the Budget that reduce issuance of government
securities (gilts) combined with slower economic growth are likely
to reduce yields available on gilts and increase the value placed
on final salary scheme liabilities. Indicatively, a 0.5% fall in
gilt yields would increase final salary scheme liabilities by about
£43bn to £143bn, Aon estimates.
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On an optimistic note, Aon feels that as tough
economic measures take effect, financial conditions will change and
are likely to be more favourable to final salary deficits. This is
because a strengthening of the economy will lead to increased
yields available on gilts and, thus, lower the value placed on
final salary liabilities. An increase in gilt yields to 1% above
current levels would reduce the deficit to £25bn, estimates
Aon.
“For those companies that can afford to take a
long-term view of pensions, the UK Emergency Budget is short-term
pain followed by long-term reward,” said Marcus Hurd, Aon
Consulting’s head of corporate solutions. “The short-term pain,
however, may be too much to bear for some companies in difficult
times.”
Some relief, however, may be on the way for
beleaguered companies. On 8 June the Department of Work and
Pensions (DWP) announced that company pension schemes will in
future be linking increases to pension payments to the consumer
price index (CPI), replacing what has until now been the link to
the retail price index (RPI).
“The move to enable pension schemes to link
future payments to CPI rather than RPI is a ray of sunshine for
companies in an otherwise gloomy couple of decades of regulation,”
said Patrick Bloomfield, a partner at actuarial consultancy Hymans
Robertson.
“While annual CPI inflation has been on average
0.7%age points lower than RPI over the last 20 years or so, CPI is
arguably a more appropriate measure of the cost of living for
pensioners than RPI as it excludes mortgage interest payments.”
Bloomfield said that changing from RPI to CPI
will be positive for business in that it could lessen the current
deficit burden of the 350 largest UK listed companies by about
£50bn. But it will hardly delight pensioners as the change could
potentially result in payments that are around three quarters of
what they may have previously received.
However, the impact on company pension schemes
is uncertain in terms of whether it will apply to accrued benefits
and, therefore, pensions already in payment, noted Bloomfield.
“The path to implement moving from RPI to CPI
is not straightforward,” Bloomfield stressed. “Pensions that have
already built up are legally protected against being worsened, so
it will be interesting to see how the government will overcome this
hurdle. We hope that the implementation is workable and not overly
complex, otherwise the potential savings will be eroded by yet more
administrative cost.”
