RBS reviews recovery plan as interest rates hurt funding level

Low interest rates have had an adverse effect on many defined benefit schemes’ funding levels. However, the capital adequacy requirement for banks, resulting from European directive Basel III, forces them to hold ‘tier one’ assets – such as retained profits and preference shares – against any deficits.

The RBS group pension fund had a deficit of £5.6bn as at March 31 2013, representing a funding level of 82 per cent on a technical provisions basis, according to the bank’s interim report published this month. The report refers to the bank’s main fund and not its smaller AA section, and represents 85 per cent of the plan’s total assets as at December 31 2013.

The funding level at its March 31 2010 valuation stood at 84 per cent, at which point the deficit was £3.5bn.

A spokesperson for the scheme said lower real interest rates, which affect the way discount rates are calculated, were responsible for the fall in funding level.

RBS contributed £375m a year for 2011 and 2012, and in the original recovery plan was set to pay £400m from 2013 until 2015, with further increases in line with inflation between 2016 and 2018.

Under the revised plan, the bank will contribute £650m a year between 2014 and 2016, reducing to £450m from 2017 to 2023, indexed in line with inflation.

The sponsor’s regular annual contributions have also risen to around £270m from £250m last year.

Meeting requirements

The capital requirements also demand that banks hold assets such as retained profits and preference shares to protect against the impact of a 1-in-200-year stress event, but the holdings can be minimised through reducing risk within the scheme.

Speaking about the impact of Basel III on banks with pension deficits, Martyn Phillips, director at consultancy JLT Employee Benefits, said: “The primary [impact] is these deficits now would get factored into their tier one capital calculation, which is what they use to underwrite their daily business.”

He added that banks were no longer allowed to factor in future deficit contributions when reporting on the pension deficit.

Russell Lee, principal at consultancy Mercer, said this could lead to increases in the capital requirement if the deficit worsened.

“If you look at the pension deficit, that’s essentially a negative asset,” said Lee. “In the past it was much easier to hide that number.

“A 10 per cent swing, even, has quite an impact on their capital requirement. It’s quite material for UK banks.” This has led a number of banks to derisk their pension schemes as a means of reducing the amount of capital needed, he added.

Questions remain over the effect of the Banking Reform Act, which ringfences the retail arm of banks to protect customers against investment bank losses, but this may have an impact on how any deficit is divided among different parts of the bank.

Phillips said the impact of the act “will depend on where the pension risk features in the balance sheet… There would need to be some way of apportioning the deficit”.