Owen Walker looks at the various changes FTSE 100 pension schemes are making to their actuarial assumptions to provide a more accurate picture of their liabilities
The decisions schemes make about how to value risks – such as the life expectancy of their members, the future impact of inflation and the return they will get on their investments – have a massive impact on their liabilities.
Under the IASB19 accounting standard, defined benefit schemes must divulge any assumptions they make about the future benefits they pay out.
The key change over the past year has been schemes changing their inflation assumptions based on the consumer prices index (CPI) rather than the retail prices index (RPI).
When in March BT adopted a long-term CPI assumption of 2.4% per year, this was a one percentage point drop from its previous RPI-linked assumption.
This resulted in £3.5bn being wiped from its liabilities – the equivalent of 9% of its total liabilities.
Bob Scott, partner at LCP, and the report’s author, said the total impact for schemes switching to CPI-linked assumptions was a reduction in liabilities of £6bn.
But he added only a third of schemes had included the impact of switching from RPI to CPI in their disclosures.
“If we extrapolate that to the full FTSE 100, we would expect overall between £10bn and £15bn as the impact,” he said. “That’s a £10bn-15bn reduction in benefits caused by lower benefits being paid.”
Video: Bob Scott discusses FTSE 100 disclosures
Another factor which has a massive impact on the value of a scheme’s liabilities is the assumptions it makes over the life expectancy of its members.
The LCP report looked at the 66 schemes which had provided sufficient information to derive mortality statistics, based on a male aged 65 years old.
This showed a continuing rise in assumed life expectancy. The average across the 66 companies was 87.1 years – up from 86.8 years in 2009.
The company with the highest life expectancy was 3i, which assumed a 65-year-old male pensioner would live to 90.3 years.
But there were examples of schemes reducing their mortality assumptions. Man Group, for example, reduced its mortality assumptions for pensioners by 1.4 years following an investigation into its membership.
Companies in the financial and healthcare sectors had on average higher life expectancy assumptions, while companies in the technology and consumer goods sectors had the lowest.
FTSE 100 schemes have also been increasing the assumptions they make on future improvements to mortality. On average, they assumed their members would gain an extra 2.1 years of life expectancy over 20 years – this was up from 1.9 years in 2009.
The scheme which had the most improved mortality assumptions was British Land Company, which now assumes a 40-year-old member would gain an extra three years of life expectancy over the next 20 years. In 2009 the company assumed just one year’s improvement.
The report also looked at how schemes calculated their discount rate, which is based on the returns the scheme estimates it will receive from high quality corporate bond investments.
Nick Bunch, partner at LCP, said: “This year we have seen a considerable reduction in the range of discount rates used by companies for their IAS19 disclosures.”
Of the schemes which reported in December 2010, the average discount rate fell to 5.4% from 5.7% a year before. The vast majority of schemes had a discount rate between 5.4% and 5.6%, which reflects falling yields on high quality corporate bonds.
Over the past couple of years schemes have on average kept similar assumptions on their expected equity returns. Legal & General has the lowest expected return, assuming 6.5% per year. InterContinental Hotels had the highest with 8.9% per year.
