UK Pension Deficits Down but Long-Term Risks Still Present

A Mercer news releasesaid its 2006 year-end projections found that plan shortfalls fell from £87 billion in 2005 to £63 billion last year. Mercer researchers were quick to caution, however, their longer term trend analysis revealed that the drop is partly a reversal of the 2005 upswing, with aggregate deficits only a fifth below the levels at the end of 2002.

“Rising funding levels are good news for pension plan members, but the underlying longevity and investment risks remain significant issues for sponsoring employers,” said Tim Keogh, worldwide partner at Mercer, in the release. “There has been little change in relative risk levels over the last four years.”

As far as risk management is concerned, Mercer said its research showed that over the last four years companies have primarily tried to manage their pension risk by reducing the level of future benefits. They did that either through cutting existing members’ benefits or closing plans to new entrants.

Although this action reduces future risks, it does not diminish the legacy exposure, which mainly comes from a plan’s investment strategy and the uncertainty surrounding member longevity, Mercer said.

While there have been many amendments to investment strategies in recent years, most have been aimed at making the risk-taking more sophisticated, while only modest reductions have been made to the overall investment risk level.  

In examining the area of pension contributions, while some employers responded to the introduction of Pension Protection Fund (PPF) levies by increasing contributions last year, Mercer said it found that tax advantages, strong cash flow and corporate deals have been the major drivers of large funding payments so far. The incentive to contribute more to a plan in order to reduce the PPF levy was small in most cases, Mercer noted.

Although the PPF is expected to increase the incentive to cut large deficits four-fold this year – which could push up contributions by as much as £18 billion if all FTSE 350 companies chose to fund at least up to the average level – this would not necessarily substantially reduce the overall burden on the PPF, Mercer said. Financially weaker companies, most of which are outside the FTSE 350, are less likely to be able to respond in this way and constitute the bulk of the risk.

New research unveiled in late December by Watson Wyatt showed the combined retirement fund shortfall of firms in the FTSE 100 fell to £39.9 billion at the end of 2006, from £60.4 billion at the end of 2005 (See UK Pension Shortfall Decreases by £20B in 2006 ).