Following the FTSE350 index over recent months has been something of a rollercoaster. Behind the headline figures, however, there has been a clear divergence in performance between the different industry sectors. Over half of the FTSE350 companies are still responsible for funding defined benefit (DB) schemes, so the health of each company’s particular sector will be watched closely by those managing the funding of these schemes.
For the FTSE350 companies sponsoring DB schemes, healthcare companies were the best performing (with overall market capitalisation up by three percent from the start of the year), while energy companies have fared the worst (with their market capitalisation down by over 40 percent from the start of the year).
Unfortunately, for many of the FTSE350 companies, behind the turbulent share price movements, there is an equally volatile legacy pension deficit that needs managing. For those tracking DB funding levels, the last few months have been slightly puzzling.
On the one hand, funding levels on the basis disclosed in company accounts have fared reasonably well (even improving significantly at one point in March as corporate bond yields spiked). On the other hand, the funding levels used to calculate contributions and to price insurance transactions have faltered, as gilt yields continued their downward march and equity markets tumbled.
For the FTSE350, the overall buyout (or solvency) deficit increased by around £45bn from the beginning of the year to the end of May. The increase in the solvency deficit has happened at the same time as a precipitous drop in market capitalisation for the FTSE350 companies – the overall solvency deficit exceeded 17 percent of the companies’ total market capitalisation at the peak of the crisis in March – double the proportion at the start of the year.
On an individual scheme level, the change in funding levels over recent months will mainly be a function of the underlying scheme investment strategy. It is important for companies and trustees to understand how things have progressed, and assess any impact that this might have on any funding plans.
The recent volatility will have provided a good illustration of the risk that companies are running (in some cases, unwittingly) through their DB scheme investment strategy – ensuring this strategy is in line with the company’s risk appetite is an important consideration for DB scheme sponsors, and an issue that should be discussed robustly with the trustees.
The capacity of each individual company to cope with a rising pension deficit will depend in part on the strength of recovery over the coming months and years, which again will vary significantly depending on the company’s industry sector.
For some companies, the Pensions Regulator’s review of the DB funding regime will not be ideal timing. In its ongoing consultation, the Pensions Regulator is proposing that schemes should put in place a plan to reach full funding on a low dependency basis once the scheme reaches “significant maturity”. Over the medium term, we expect this to result in additional cost for companies, as the funding gap will not be made up from investment returns alone.
It is clear that sponsoring employers and trustees will have a delicate balancing act to manage over the next few years. Employers will be looking to conserve cash and / or rebuild their businesses whilst trustees will be concerned about the security of members’ benefits. A key priority will be agreeing an endgame strategy for the scheme; working out what the ultimate destination of the scheme is (buyout, consolidator, low risk run-off etc.) and how to get there within acceptable cost, risk and time constraints. While sponsor and trustee objectives will not always align exactly, in most cases it should be possible to set a journey plan that works for both the sponsor and trustees.
Barnett Waddingham’s full report can be downloaded here.
Barnett Waddingham’s DB Navigator approach gives you the knowledge, structure and tools to optimise your strategy for your DB endgame. If you would like to find out more, please get in touch with Simon Taylor.
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