Analysis: While there has been a recent improvement in defined benefit pension fund deficits, market volatility, weak covenants and increasing longevity mean trustees should continue to keep a tight rein on risk and cost management.
The IAS 19 deficit for all UK private sector schemes fell to £176bn in June, from £209bn at the same time last year, according to JLT Employee Benefits’ monthly funding update.
It’s those with a poor employer covenant where the problems are most acute
Charles Cowling, JLT Employee Benefits
And research carried out by consultancy Mercer showed the accounting deficit of FTSE 350 DB schemes fell by £3bn to £131bn between May 30 and June 30 this year.
Prepare for potentially higher DRCs
But despite slight improvements over recent months, deficits are still significantly higher than three years ago for a number of reasons, including increased life expectancy.
Mercer’s data shows IAS 19 deficits for FTSE 350 schemes were as low as £52bn at the end of December 2013.
Ali Tayyebi, senior partner at Mercer, said that although there has been a fall, the change was relatively small in the grand scheme of things, noting that deficits are still larger than they used to be.
He said companies looking to renegotiate deficit contributions this year are likely to be comparing their position to the last actuarial valuation, which might have been three years ago.
“Many schemes are likely to find that the deficit is still significantly bigger than it was the last time they agreed contribution rates,” he said.
Charles Cowling, director at JLT Employee Benefits, acknowledged that a lot depends on the schemes being surveyed and the numbers used.
Many schemes will not have carried out a valuation for three years, so it could be that the deficit is bigger than it was three years ago, leading to “a discussion about paying more on contributions”, Cowling said.
Keep an eye on your covenant
A number of cases over recent years have highlighted the importance of covenant strength, including the BHS scandal and Hoover’s agreement with the Pensions Regulator on a regulatory apportionment arrangement.
“It’s those with a poor employer covenant where the problems are most acute,” said Cowling.
A new report, on the risk of DB members not receiving their benefits in full, highlights that the current funding position of a scheme is less important than the strength of the covenant supporting the scheme.
“While the level of deficit has an impact, as long as it’s affordable by the company in the long term it doesn’t really matter. It matters whether the company’s going to be around for the long term,” said Richard Jones, managing director of Punter Southall Transaction Services, and co-author of the report.
The regulator, which has just been granted £3.5m of additional funds to support its compliance and enforcement work, is likely to be looking at affordability in more detail, Cowling said.
This means that “they’re going to scrutinise more valuations this year… and more companies and more trustees are going to have to face questions on their policy on deficit recovery”, Cowling said.
Simon Taylor, partner at Barnett Waddingham, said the slight improvement in the aggregate deficit is unlikely to be indicative of an overall trend, but down to market movements.
Employers urged to actively manage covenant
Employers and schemes must take a more active approach to managing their pension liabilities to improve covenant strength, experts say.
“Companies and trustees should continue to review their strategies and, if deficits do continue to improve, consider whether it would be appropriate to reduce risk in their DB schemes,” he advised.
What can trustees and sponsors do?
Jones highlighted that contingent assets can help prop up scheme funding. “The best types of contingent assets are those that have a value that’s independent of the funding position of the scheme,” he said.
He also noted that liability-management exercises are useful to reduce cost and risk, arguing that trustees need to become even more open to this type of exercise.
Some, including DB transfers, “improve the security of the position of the remaining members, and they’re something that the leaving members want to do”, he said.
Jones noted that schemes are “better off, from a member perspective, to actually spend the money on getting people to transfer, rather than just chucking it into the pension scheme and leaving it there”.
