US Pension Fund Deficits Set To Grow While UK Pension Fund Deficits Level Out, Says Aon

The overall pension deficit among major U.S. companies in the Fortune 100 is expected to increase significantly by year end, from $78 billion in December 2004 to an estimated $129 billion by December 2005 an increase of 65% unless company

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The overall pension deficit among major U.S. companies in the Fortune 100 is expected to increase significantly by year-end, from $78 billion in December 2004 to an estimated $129 billion by December 2005 — an increase of 65% — unless company contributions are increased or market conditions improve by the year-end. This is according to analysis from Aon Consulting.

However, while the overall deficit among the Fortune 100 is set to rise, the overall deficit held by 200 of the largest companies in the UK at the end of 2005 is expected to remain relatively unchanged from 2004 levels at just under 70bn pounds Sterling, based on market conditions as of October 31, 2005.

According to Aon Consulting, likely factors contributing to the increase in overall pension fund deficit levels among the Fortune 100 during 2005 include: a 9 basis point drop in the discount rate, increasing the liabilities by about 1.5%; investment returns much lower than expected on stocks and bonds through October; and lower levels of contributions during 2005 from companies.

However, it is anticipated that contributions will increase over expectations during 2005 as companies decide to contribute more to reduce or eliminate any additional minimum liability under FAS 87 at the end of 2005. Companies predicted at the start of the year that they would only have to pay cash contributions of $20 billion(2). Last year they made cash contributions of around $35 billion.

Commenting on the likely rise in the U.S. pension plan deficit, Brad Klinck, senior vice president with Aon Consulting in the U.S., said: “It is clear that U.S. deficit levels have been highly susceptible to change in recent months — ranging from 79% to 91% funded from December 04 to October 05. We expect this volatility to continue for the rest of this year. The potential increase in U.S. pension plan underfunding shown by our analysis is largely the result of low interest rates, low investment performance, and lower corporate funding of pension plans. The lower corporate funding is, in many cases, being caused by government policies and the concern that potential changes to the U.S. funding rules may effectively penalize plan sponsors that contribute this year.

“With regard to interest rates, we could well see a rise in rates over the remainder of the year. With a combination of interest rates rising by 35 basis points in the remaining two months and assets returning their expected gains, the unfunded at year end will remain roughly unchanged from the end of last year.”

In the U.K., discount rates have also fallen, thereby increasing the liabilities by almost 10%. However, this 10% increase in liabilities has been offset by a slightly higher than 10% increase in pension plan assets. In fact 2005 has been a surprisingly stable period for FRS17 deficits overall; Aon estimates that the total deficit has remained in the range 69bn pounds Sterling to 58bn pounds Sterling, reaching its lower level at the end of July, but then increasing over the last few months as a result of falling index- linked gilt yields.

Andrew Claringbold, from Aon Consulting in the U.K., said: “While pension scheme funding levels have remained fairly stable in the U.K. this year, the experience in the U.S. shows that small movements in markets (particularly bond markets) can cause significant movements in funding levels. In the U.K., the funding level is particularly sensitive to index-linked gilts and the corporate bond yield spread over gilts. If either index-linked gilt yields or the corporate bond yield spread rose by only 0.5%, then the FRS17 deficit would fall by over a half.”

With reference to the recent consultation document issued by the Pensions Regulator in which it set out its proposed approach to funding, Andrew Claringbold added “Cash contributions to U.K. pension funds have increased significantly over recent years. Based on the companies in our survey, cash contributions increased from around 8bn pounds Sterling in 2003 to an estimated amount of 13bn pounds Sterling in 2005. If companies pay cash contributions in line with the suggested targets and amortization periods suggested by the Regulator, then based on current funding levels, we estimate that cash contributions will have to increase further to 15bn pounds Sterling each year.”