London, 10 November, 2005 – The overall pensions deficit amongst major companies in the United States (US) Fortune 100 is expected to increase significantly by year-end, from $78 bn in December 2004 to an estimated $129 bn by December 2005 - an increase of 65% - unless company contributions are increased or market conditions improve by the year-end. This is according to analysis¹ from Aon Consulting, a leading pension, benefits and HR consulting firm.
However, whilst the overall deficit amongst the Fortune 100 is set to rise, the overall deficit held by 200 of the largest companies in the United Kingdom (UK) at the end of 2005 is expected to remain relatively unchanged from 2004 levels at just under £70bn, based on market conditions as at 31 October 2005.
According to Aon Consulting, likely factors contributing to the increase in overall pension fund deficit levels amongst the Fortune 100 during 2005 include:
· A 9 basis point drop in the discount rate, increasing the liabilities by about 1.5%.
· Investment returns much lower than expected on stocks and bonds through October.
· Lower levels of contributions during 2005 from companies – however, it is anticipated that
contributions will increase over expectations during 2005 as companies decide to contribute more to reduce or eliminate any additional minimum liability under FAS 87 at the end of 2005. Companies predicted at the start of the year that they would only have to pay cash contributions of $20 billion². Last year they made cash contributions of around $35 billion.
Commenting on the likely rise in the US pension plan deficit, Brad Klinck, from Aon Consulting in the US, said: “It is clear that US deficit levels have been highly susceptible to change in recent months - ranging from 79% to 91% funded from December 04 to October 05. We expect this volatility to continue for the rest of this year. The potential increase in US pension plan underfunding shown by our analysis is largely the result of low interest rates, low investment performance, and lower corporate funding of pension plans. Tragically, the lower corporate funding is in many cases being caused by government policies and the concern that potential changes to the US funding rules may effectively penalize plan sponsors that contribute this year.
"With regard to interest rates, we could well see a rise in rates over the remainder of the year. With a combination of interest rates rising by 35 basis points in the remaining two months and assets returning their expected gains, the unfunded at 12/31/05 will remain roughly unchanged from 12/31/04.”
In the UK discount rates have also fallen, thereby increasing the liabilities by almost 10%. However, this 10% increase in liabilities has been offset by a slightly higher than 10% increase in pension scheme assets. In fact 2005 has been a surprisingly stable period for FRS17 deficits overall; Aon estimates that the total deficit has remained in the range £69bn to £58bn, reaching its lower level at the end of July but then increasing over the last few months as a result of falling index-linked gilt yields.
Andrew Claringbold, from Aon Consulting in the UK, said: “While pension scheme funding levels have remained fairly stable in the UK this year, the experience in the US shows that small movements in markets (particularly bond markets) can cause significant movements in funding levels. In the UK, the funding level is particularly sensitive to index-linked gilts and the corporate bond yield spread over gilts. If either index-linked gilt yields or the corporate bond yield spread rose by only 0.5%, then the FRS17 deficit would fall by over a half.
“With reference to the recent consultation document issued by the Pensions Regulator in which it set out its proposed approach to funding, Andrew Claringbold added “Cash contributions to UK pension funds have increased significantly over recent years. Based on the companies in our survey, cash contributions increased from around £8bn in 2003 to an estimated amount of £13bn in 2005. If companies pay cash contributions in line with the suggested targets and amortisation periods suggested by the Regulator, then based on current funding levels, we estimate that cash contributions will have to increase further to £15bn each year.”
1. The research is divided into two parts:
- The UK research looks at the disclosure of pension information of 200 of the largest UK companies – including all UK FTSE 100 companies with DB plans; a significant proportion of companies from the FTSE 250 with DB plans, and; the remaining number of companies were listed with the NAPF, as having pension fund assets in excess of 100m.
- The US research looks at disclosure of pension information of 80 Fortune 100 companies sponsoring defined benefit pension plans for which information was available in company annual reports.
The Aon Consulting research compares pension information data for US companies (using FAS87 accounting rules) with similar data for UK companies (using FRS17 accounting rules). Assets are measured on a market value basis in both countries. While FAS 87 allows the use of a "smoothed" asset value for purposes of calculating the annual pension expense, we used market value in all calculations. Liabilities are measured using the projected unit credit method with a discount rate based on current high-quality corporate bonds in both countries. Therefore, in theory the liabilities are comparable between the countries.
2. Aon based its US projections on the assumption that companies would only have to pay cash contributions of $20bn
About Aon Consulting
Aon Consulting is a leading human capital consultancy, helping organisations of every size to attract and keep the employees they need. We advise on all aspects of employment, including health-related insurance and risk; employee compensation and pensions; human resource strategy planning; job design and change management; and staff assessment and legal issues.
Aon Consulting is a division of Aon, the UK's largest insurance broker and provider of risk management services and a major force in reinsurance and the UK human capital consulting market. Aon Consulting Limited is authorised and regulated by the Financial Services Authority.
About Aon
Aon Corporation ( http://www.aon.com ) is a leading provider of risk management services, insurance and reinsurance brokerage, human capital and management consulting, and specialty insurance underwriting. There are 47,000 employees working in Aon's 500 offices in more than 120 countries. Backed by broad resources, industry knowledge and technical expertise, Aon professionals help a wide range of clients develop effective risk management and workforce productivity solutions.
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