Only four in ten of Britain’s largest companies retain final salary schemes that are open to new members. This compares with nearly two in three a year ago. The findings, by Mercer Human Resource Consulting, are based on a study of the latest FTSE 350 annual reports with December 31 2002 year-ends.
Many companies now offer a combination of both final salary and money purchase pensions. Only 25% have not yet opened some form of money purchase scheme, compared to 45 % last year.
“Undeniably, there has been a huge shift in the nature of pension provision in recent years,” says Tim Keogh, European Partner at Mercer Human Resource Consulting. “But it would be an oversimplification to say that final salary schemes are dying out.”
“A striking development in recent months is the number of employers re-committing to final salary schemes, but rebalancing the costs. Many companies are changing the cost structure of their schemes, such as increasing employee contributions or adjusting the rate at which benefits can be built up,” he adds.
“Significant numbers of employers have sought to cut costs by closing their final salary schemes to new entrants. Such measures will help reduce the cost of future liabilities but will have little effect on current deficits,” says Keogh.
Since last year, the median funding level has fallen from 91% to 74%, based on the FRS17 accounting measure. This is equivalent to a loss of 4% of the market capitalisation of these companies, though the range is up to 35%.
“Clearly, pension deficits are not uniformly distributed amongst all companies. For a substantial minority of organisations, managing this deficit is a major issue,” explains Keogh.
Extrapolating to companies with other year-ends, Mercer estimates that the aggregate FRS17 deficit for FTSE350 companies is about 90bn, including 77bn in the FTSE100. This includes up to 15 billion of overseas liabilities – such as healthcare liabilities in Germany and the US – many of which are not backed by assets in line with local practice. These overseas exposures are not new, though they may have had a lower profile up to now.
If overseas liabilities are excluded and non-FTSE350 companies recognised, these figures can be extrapolated to give an FRS17 deficit of around 150bn for UK schemes as a whole. This becomes 300bn if consideration is given to the cost of winding up schemes by securing insurance policies, or converting to insurance companies in the case of the largest schemes.
“We wait to hear, with interest, which of these numbers will be adopted by the Government to determine levies for the forthcoming Pension Protection Fund,” says Keogh.
Mercer’s research also shows that the median pension cost has risen from 6% to 8% of pre-tax profits over the year. This is a highly company-specific figure; the charge is less than 3% for the least exposed quarter and more than 17% for the most exposed quarter.
Profit impact tends to be higher amongst the FTSE250, where the median pension cost is 10% of profits against 6% in the FTSE100.
The equity allocation by pension funds fell from 67% to 60% over the last year, with bonds taking up the slack. Individual holdings varied significantly from 33% to 83%.
“The prevalence of equity investment has continued to fall,” comments Andy Green, Head of Investment Strategy at Mercer Investment Consulting. “Though individual schemes will have taken different actions, the overall drop in equity allocation is consistent with the fall in absolute value of equities compared to other investment classes, rather than a net disinvestment.
“Over time, we expect to see falls in equity holdings as trustees seek to diversify their risk exposure. But the level of disinvestment is likely to be modest, and any reduction in equity allocation will be partly achieved from schemes’ increased cash-flows being directed to bonds and alternative investments.”
Mercer says the large difference between FRS17 and insurance company costs arises because of the capital reserving and additional regulatory requirements for insurance companies that do not apply to ongoing pension schemes.
The top and bottom 5% of outliers are excluded from all percentage ranges quoted, in order to avoid large distortions.
Mercer’s research draws on data for all 147 FTSE350 companies with 31 December year-ends, using its Evaluate data-logging and analysis system. This number is around 50% of the companies logged – pure investment companies such as investment trusts and property companies are excluded as they effectively package other investments and do not have meaningful staff overheads.