FTSE 100 DB surplus not immune to funding code and inflation shocks

Pensions Expert reported in September on the challenges posed by inflation, which rose to 3.2 per cent in August from 2 per cent in July, according to consumer price index figures from the Office for National Statistics.

The level of inflation hedging will partly determine the impact on pension schemes, but much depends on whether inflation proves transitory or lasting, experts said.

LCP has warned that sharp rises over recent months could “flow through” to pension increases, with many schemes determining these according to September’s inflation figures, to be published later this month.

“If current trends persist, it could potentially increase FTSE 100 pension liabilities by up to £10bn,” the consultancy warned, though it noted that most schemes will be "protected to an extent by inflation-linked assets”.

The Pensions Regulator’s new DB funding code, on which it will be consulting later this year, could also have a material impact.

The new code establishes a twin-track funding arrangement: a fast-track, under which schemes would be subject to less regulatory scrutiny; and bespoke, under which schemes would face stricter oversight. 

The industry has long been concerned that the fast-track route would be too prescriptive, and the bespoke route tied too tightly to it, rendering it second best — though in an interim response earlier this year, the regulator said many of these concerns stemmed from “misunderstandings around what we had proposed”.

LCP explained that, under the proposed rules, deficits for companies with strong covenants would have to be met more quickly, with the fast-track route potentially saddling FTSE 100 employers with additional annual deficit contributions of £5bn.

“For companies with an IAS19 surplus, careful messaging on why new contributions could be required will be needed for investors and shareholders,” the consultancy explained.

“The default in the new rules will mean that schemes would be expected to target low-reliance on the scheme’s sponsor and potentially fund on a more prudent basis," it added.

As a result, LCP predicted "that many sponsors will investigate the bespoke route, and this is likely to mean an increase in the use of contingent assets as companies seek to provide appropriate security to their pension schemes, whilst balancing the needs of all stakeholders".

While only 10 FTSE 100 companies show an IAS19 deficit at present, that figure could jump to 32 under the new funding regime, LCP said.

In total this could mean an additional £5bn a year of deficit contributions would be required to plug the gap, including more than £1bn a year of contributions for companies disclosing a surplus in their corporate accounts, it noted.

Jonathan Griffith, partner at LCP, said: “It’s good news that we are seeing sustained accounting surplus figures, and the volatility of 2020 is now hopefully behind us. However, the upcoming changes to the funding regime mean that many schemes — even those with an IAS19 surplus — are more vulnerable to being asked to make additional cash to meet new funding deficits, unless they take a proactive approach and provide alternative forms of security.”

“Analysis we did earlier this year showed that only 10 per cent of schemes showed a surplus on the more prudent basis of the proposed fast-track approach,” he continued. 

He added: “Whilst this position has improved to date, for many companies sponsoring larger pension schemes, the bespoke route will make sense and will ensure the appropriate level of protection is provided in a way that uses corporate resources efficiently.

“Our message is that scheme sponsors need to understand the proposals, work out how their scheme will be impacted and not be misled by the rising IAS19 surplus figures. Doing this work now will save some potentially nasty shocks and surprises further down the line.”