Credit crunch and pensioner longevity increase pension deficits

The level of funding in defined benefit schemes in FTSE 100 companies fell to a deficit of £41bn by mid July 2008, compared to a surplus of £12bn in July 2007.
The findings, from Lane Clark & Peacock’s (LCP) report Accounting for pensions 2008 shows that the credit crunch, equity market volatility and rises in expected inflation are prime causes of the severe swing.
Referring to last year’s brief period of pension surplus, Bob Scott, partner at LCP, said: “Some companies chose to spend their surpluses on various forms of de-risking activity including buy-outs, purchasing financial swaps and reducing their exposure to equities.
“Events of the last year demonstrate the importance of assessing and managing pension risks and being prepared to take opportunities when they present themselves.”
Jerome Melcer, partner at LCP added: “Funding held up strongly in the first nine months of the year only falling heavily in the past three months.”
However, he pointed out that the IAS19 reporting standard had “cushioned” the effect on balance sheets. IAS19 requires employers to value liabilities using corporate bond yields, which have risen to unprecedented levels compared to gilts. “Without IAS19 the deficit would have been £90bm, not £41bn,” he said.
Over the past three years, FTSE 100 employers have pumped nearly £40bn into their pension schemes, while the average level of equity investment has fallen sharply from 59% to 53% over 2007. Melcer described this move away from equities as the largest annual drop that Lane Clark & Peacock had seen.
In addition, improved longevity assumptions by UK employers added £9bn to FTSE 100 deficits between 2006 and 2007. Adam Poulson, partner at LCP, said:†“After equity variability, the next variable affecting liabilities is longevity.” On average, FTSE 100 employers are making the assumption, that UK men retiring at 60 years will live until 85.5 – up from the 84.8 years assumed in their pension scheme accounts for 2006. “Our research shows that UK companies have stepped up and are using more robust [longevity] assumptions,” said Melcer.
Research has shown that two of the main indicators of life expectancies are socio-economic group and income. Analysing assumed life expectancies of FTSE 100 employees according to sector, LCP found that the highest assumed life expectancies are in the healthcare, financial, consumer services and industrial sectors. The lowest assumed life expectancies are in the oil and gas, and telecoms sectors.
For example, AstraZeneca and Smith & Nephew increased their longevity assumptions by well over three years compared to last year’s accounts, so that pensioners in the healthcare sector are now assumed to live more than 2.5 years longer on average than members in any other sector.
Assumed salary growth has also affected projected pensions, so with the average real salary increase falling slightly over the past year, this has helped reduce deficits.