FTSE 100 schemes in surplus, but experts warn that risks remain

The report, published on Tuesday, estimated that the overall funding level for FTSE 100 schemes increased from 95 per cent to 101 per cent over 2017, with a £31bn deficit having transformed into a £4bn surplus by the end of the year.

Just because it looks good on an accounting basis, [that] doesn’t mean the risk isn’t there

Stefan Lundbergh, Cardano

Since then, the study estimates the surplus figure improved further to over £20bn at the end of April 2018.

New methods to set discount rates

There are three main reasons for the improvement, according to the study. One is that many schemes experienced strong investment growth over the year.

The other is that companies contributed £13bn into pension plans, which is more than double the cost of the extra benefits members earned in the year.

A third factor is a step-change in discount rate approaches. Companies updated life expectancy and inflation assumptions and adopted new methods to set discount rates to largely negate deteriorating financial conditions.

The study estimates that, over the past two years, companies have used this to improve balance sheets by around £15bn.

While on some occasions there has been a combined surplus in the past 15 years, it has been swiftly wiped out by market conditions, the study notes, adding that it remains to be seen if the current surplus is here to stay.

The consultancy has also warned that IAS 19 changes earlier this year will alter how some companies account for special events like benefit changes and liability management.

Furthermore, potential changes to IFRIC 14 accounting standards could worsen the balance sheets of FTSE 100 companies by around £50bn.

Accounting figures "misleading"

Phil Cuddeford, LCP partner and lead author of the report, said that “whilst, overall, the FTSE 100 companies have a surplus as measures by the accounting basis, that does not translate into there being a surplus on the cash funding basis”.

This means that “there will be a significant number of companies who are simultaneously saying in their accounts that they’ve got a surplus”, according to IAS 19 accounting standards, “but they’re also still paying in deficit contributions”, he said.

Recent high profile pension cases have increased the amount of scrutiny on company dividend payments and pension scheme contributions.

The LCP report showed that over 2017, FTSE 100 companies paid roughly £80bn in dividends, which is six times the £13bn paid to their UK pension funds.

Companies should ensure they have fully considered all stakeholders, including the trustees’ point of view and the Pensions Regulator’s perspective, before pushing ahead with large dividend payments, Cuddeford noted.  

It is important “to make sure that whatever they decide about the relative allocation of their cash resources between shareholders, their pension scheme and other stakeholders is something that they can justify as being a fair, reasonable allocation,” he said.

Richard Farr, managing director at Lincoln Pensions, said deficits do not tell the whole story.

“As is well known, the accounting figure can be quite misleading and we hope that, one day soon, companies will make improved disclosures of the true funding requirements of their pension funds and the scale risks they contain,” he said.

As Cuddeford pointed out, pension funds use a different measure to the accounting basis that features in company balance sheets.

Save for a rainy day

Stefan Lundbergh, head of insights at Cardano, agreed that “accounting figures can be… misleading”.

He said there is a risk of people thinking that, “on an accounting basis we’re fine, so we’re out of the woods”. However, if the market and economic conditions deteriorate, companies and schemes that have not prepared may be in for a nasty surprise.

Being sufficiently prepared means that “if, or when, the downturn comes, you can weather the crisis in a much more robust way”, he noted.

Lundbergh highlighted the importance of trustees communicating with the sponsor to make it clear that “just because it looks good on an accounting basis, [that] doesn’t mean the risk isn’t there”.

“Save for a rainy day… because if [the market downturn] comes, you’re going to be very happy that you did it,” he added.