The coronavirus pandemic has so far had a limited impact on the net funding position of UK FTSE 100 defined benefit (DB) pension schemes, a new report from consultants Lane Clark & Peacock (LCP) has revealed.
The study shows that the near total shutdown of the UK economy in response to the COVID-19 outbreak has left funds treading water to end March broadly in the same position as at the start of the year.
LCP partner Jonathan Griffith said: “Before the economic earthquake of COVID-19, a large number of FTSE 100 pension schemes were in a relatively healthy position, with most reporting a surplus in their company accounts.
“The pandemic has thrown all this up in the air as discount rates and asset values are impacted by the market volatility.”
Some 60% of sponsors had reported an accounting surplus in their pension scheme on an IAS19 (International Accounting Standard 19, Employee Benefits) accounting basis for 2019, rising to 70% in surplus – their best position for 20 years – by March this year.
However, just one month later, that figure had fallen below 60% again as the pandemic hit.
Moreover, the LCP analysis reveals that between 10 March and 18 March, debt-market volatility and rising interest rates wiped some £150bn (€167bn) from the total pension liabilities as investors sought shelter in fixed income.
The development effectively balanced out Q1’s precipitous falls on global equity markets.
The LCP study noted that two factors have served to shield FTSE 100 scheme sponsors from the worst effects of recent market turmoil.
First, their combined asset holds are currently split 60/20 in favour of bonds over equities. This compares with the position in 2002 when just over 60% of fund assets were allocated to equities and less than 30% to bonds.
Second, funds with extensive hedging strategies in place will have seen their liabilities reduced.
Meanwhile, the key IAS 19 assumptions of discount rates, inflation and mortality, have also seen noteworthy developments.
Since 31 December 2018, discount rates have fallen from around 2.8% to between 2% and 2.1% at 31 December 2019, which has had the knock-on effect, in isolation, of increasing scheme liabilities by around 15% – some £70bn for FTSE100 sponsors alone.
Inflation
On inflation, sponsors based their IAS 19 assumptions on a breakeven inflation assumption of some 3.2% less an inflation risk premium of between 0.2-0.3%.
This risk premium is slightly higher than in previous years. The report’s authors suggest it could “be as a result of the increased uncertainty in the market and the perception that perhaps investors require additional returns if they were to hold inflationary risks in the current climate.”
The report also noted that sponsors were beginning to adapt their IAS 19 assumptions to Retail Price Index inflation reform in the UK, which will eventually see the measure replaced with the CPIH measure.
But, cautioned the report, the impact of that reform remains, however, uncertain.
Mortality
On the third key assumption – mortality – the study revealed some disparity among sponsors over mortality assumptions.
Although a clear majority in a sample of 45 samples had updated their mortality assumptions to take account of the latest developments in the CMI 2018, a significant minority relied on earlier iterations of the CMI dating back to 2013.
The report disclosed that this introduced a level of subjectivity into the reporting that they value at some £50bn.
The report focused on the DB net balance sheet position in the sponsor’s year-end financial statements. It did not take in the funding position, which represented a cash call on the sponsor.
Dividends
Finally, on the now contentious topic of dividend payments to shareholders, the report said that around one-third of FTSE 100 companies had either cancelled or deferred planned dividends.
This move comes not just as a result of the COVID-19 outbreak but also in the face of growing pressure from the UK Pensions Regulator to strike an equitable balance between the interests of shareholders and pension scheme members.
Most recently, the regulator had insisted that sponsors could only suspend or reduce deficit contributions if they halted dividend payments.
LCP’s full report can be viewed here.
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