UK Pension Deficits Widen 50%?

The UKPA reports, Pension fund deficit 'widens 50%':

The funding shortfall faced by the UK's biggest pension schemes has widened by 50% during the past four years, research has suggested.

The deficit of the UK's 200 largest defined benefit schemes, including final salary pensions, remained broadly stable during November, rising by only £2 billion to £71 billion, according to consultancy firm Aon Hewitt.

The group said if the recent pattern continued into December, 2010 would have been one of the most stable years for pension scheme funding since 2006.

But despite the recent stability, the group said the funding shortfall faced by the 200 largest schemes had still soared by 50% during the past four years, rising from an average of £55 billion during 2006 to one of £87 billion this year.

Sarah Abraham, consultant and actuary at Aon Hewitt, said: "In the aftermath of the financial crisis, pension deficits crept up to record highs. In mid-June 2010, the deficit reached its highest level of £112 billion.

"In recent months, deficits have started to reduce, although this trend appears to have stalled. Stability is a good thing for any company trying to get a handle on the size of its pension scheme obligations, however, many employers will have been relying on further market recovery to recoup some of the losses incurred in recent years."

But the group said the Government's proposals to change the measure of inflation that pensions must be increased in line with each year from the Retail Prices Index to the Consumer Prices Index, which tends to be lower, would have a big impact on the deficits. It estimates that the move could reduce the shortfall the 200 biggest defined benefit schemes face by around £35 billion - effectively halving the current deficit.

Ms Abraham said: "Depending on regulation and how it is approached by companies and trustees, and as a result of the shift from RPI to CPI, we predict a decrease of up to £35 billion to the Aon Hewitt 200 deficit.

"This is large enough to make a dent in the deficit of the Aon Hewitt 200, but is nowhere near enough to wipe out the aggregate deficit and send it into surplus."

Defined-benefit pensions have become increasingly expensive to offer in recent years in the face of investment volatility and increased life expectancy.

Commenting on the shift from RPI to CPI, Louisa Peacock of the Telegraph reports, Pensions RPI link could be revoked to save £100bn:

A Government consultation is today expected to unveil how companies that have the Retail Prices Index (RPI) measure of inflation "hard wired" into their schemes can benefit from linking payments to the Consumer Prices Index (CPI), which excludes housing costs.

The Government first announced the switch from RPI to CPI in the June Budget, which pensions experts said could reduce the estimated £239bn pensions black hole by about £100bn.

However, industry figures warned in July that companies with schemes that had RPI expressly listed as the statutory payment could not take advantage of the new rules unless the law changed. This is because it would be a worsening of benefits.

Speaking at the National Association of Pension Funds (NAPF) conference yesterday, employment minister Steve Webb said today's consultation would look at how to "make it easier" for all companies to take advantage of the switch.

Communications giant BT revealed last month that linking pension increases to CPI reduced its mammoth pension fund deficit from £7.9bn to £5.2bn.

But NAPF research, published today, found 61pc of companies have RPI stated in their pension schemes, meaning the majority of companies would be unable to switch to CPI unless the Government overruled the current legislation.

Almost half (48pc) would make use of a new legal power to switch to CPI, while just 21pc would not – preferring to maintain generous benefits for current and future staff, the study of 162 employers found.

Joanne Segars, NAPF chief executive, said: “The question of whether a pension can move to CPI is making it very difficult for pension funds to plan ahead. The Government has significantly underestimated the complexity of letting schemes switch their inflation measure. A seemingly simple change has become much trickier."

However, Ms Segars said allowing companies to switch to CPI does not necessarily mean they would. "There are implications for current and future pensioners," she said. "Trustees and employers know that any switch must be handled carefully."

Nick Griggs, an employment partner at Barnett Waddingham, said: "[The consultation] is welcome news for a significant number of employers. Whilst it is going to be hard to implement it will hopefully remove the drafting lottery that could have existed depending on whether RPI was hard coded into the rules or not.

"Whilst members will rightly find it difficult to accept a reduction in their benefits this must be considered in the context of the ever increasing cost of final salary benefits that employers have had to bear in recent years.”

The CBI urged the Government in July to bring in a piece of "overriding legislation" so that all companies could benefit from the switch, expected in April 2011.

Switching to CPI will significantly reduce UK pension deficits, but it won't eliminate them. And the switch won't be easy to implement. There will be opposition as many feel the CPI grossly underestimates the true inflation rate. Indeed, industry experts believe companies could be sued by their pension schemes if government plans to cut costs using lower inflation assumptions for public sector pensions are copied by the private sector.

But with the pension black hole getting larger, there is pressure to reign in pension deficits using any means possible, including switching the inflation measure that is used for cost of living adjustment. Policymakers around the world will be watching these developments closely as they struggle to cope with ever widening pension deficits in their countries.

Below, UK pensions minister Steve Webb, who has vowed to 'make it easier' for companies to benefit from the RPI switch, discusses some changes his government has proposed to bolster the pension system. It remains to be seen how smoothly the switch to CPI will go.