(July 25, 2012) — The organisation representing businesses in the United Kingdom has warned that the frequency of reporting pension scheme funding levels could harm economic recovery, as figures confirm the country went back in to recession in the second quarter of the year.
The Confederation of British Industry (CBI) today urged action to address both artificially high deficit figures, driven by low gilt yields, and a potentially significant hike in the cost of the Pension Protection Fund (PPF) – the lifeboat for bankrupt pension funds – to businesses.
The CBI said: “The Bank of England’s necessary Quantitative Easing (QE) programme and the relative attraction of UK government debt over that of some Eurozone countries have driven down gilt yields. As gilt yields are used in valuing the likely cost of future pensions, this has pushed deficits up, even though there has been absolutely no change in the underlying funding position.”
Pension fund organisations and several industry figures have called for alternative methods of QE that could involve purchasing unwanted corporate debt from banks’ balance sheets and in turn improving the health of the financial sector. So far there has been no indication from the government or Bank of England that this is likely.
British business is the generator pushing the economy – today the Office for National Statistics revealed that the UK economy was back in recession after three straight periods of contraction.
More worryingly for politicians, the 0.7% contraction was much worse than had been forecast and followed shrinkage of 0.3% in the first quarter of the year and 0.4% in the final quarter of 2011.
John Cridland, CBI director-general, said: “A solvent, profitable company as sponsor is the best protection for a pension scheme and its members. Artificially high deficits will only hold businesses back further from investing and creating new jobs because of demands for higher funding from trustees.
“A move of the gilt yield by just 0.4%, can add up to £100 billion in costs to business, despite nothing about the scheme or the employer having changed. This makes no sense – pension schemes have liabilities that run for a century or more and can afford to be more long-term.”
Gilt yields have remained at record lows over several months forcing businesses that have had to issue financial reports to show significantly higher liabilities than might have been the case.
On a more accurate method of calculating the pension liabilities, Cridland said: “Using spot rate marked-to-market valuations to calculate defined benefit pension liabilities doesn’t make sense, especially given the length of time employers pay into a pension. Introducing smoothing – over a number of years – in the discount rate would better reflect the long-term nature of pensions and allow for counter-cyclicality.
Cridland added that other countries had already moved on this issue: “Denmark, the Netherlands and the US [are] taking action to spread the value of the return, rather than at a single point in time, and reflect the long-term nature of the scheme.”
The CBI suggested asking an independent body to set a rate against which to discount pension liabilities that was not based on gilts, but a more relevant number.
An additional problem caused by poorer funding levels for corporate pension funds and their sponsoring employers has been the potential rise in the levy paid to the PPF. The lifeboat steps in should an employer fail and the pension fund is unable to meet its payment promises. It is funded by a levy on all UK companies which is calculated using the amount of risk the pension fund has – which includes its likelihood of not being able to meet its promises. As a result, this levy payment could rise by 25%.
The CBI has called on the government to cap this potential increase as it is “not sustainable”.
However, in response, PPF executive director for financial risk, Martin Clarke, said: “Our levy framework is designed to respond automatically to changes in risk, something that was welcomed by levy payers and their representatives when it was introduced, after much consultation, last year, together with a levy reduction.
Clarke said conditions for defined benefit funds had deteriorated and led to a six-fold increase in risk therefore the levy rise should come as “no surprise.”
He continued: “In the first four months of this financial year, we have already accepted schemes into our assessment period with aggregate deficits that exceed our annual levy. While the PPF is in good shape to provide robust protection for the hundreds of thousands of people who rely on our compensation, this protection comes at a cost.”
The PPF has agreed that 25% will be the maximum increase in cost for pension funds in the financial year 2013/14.