UK - Standard & Poor's has issued guidelines aimed at helping UK pension schemes formulate both policy and a timeframe to eliminate scheme deficits.
The guidelines reflect scheme maturity as well as the potential risk of sponsor failure.
“We are providing trustees, for the first time, with a benchmark for determining a prudent period to remove any deficit in their scheme,” said Jim MacLachlan, director of pension services at Standard & Poor’s.
“This should give them a more objective measure for making one of the most critical decisions required of them under the new regime.”
Meanwhile, Hewitt Associates has estimated that the aggregate pension deficit for FTSE100 companies has only improved slightly since the beginning of 2004 and, at the half-year point of 2005, despite the recent upturn in equity markets, remains at around £50-60bn, measured against the company accounting standard FRS17.
Raj Mody, pensions consultant at Hewitt Associates, said:Investment returns are not resolving pension black holes and additional cash contributions are not affordable in many cases: a quarter of companies need extra contributions equivalent to a full year's profits - and more than 10% of companies need over three years' profits. Other options need to be considered and action must be taken. Neither employers nor trustees can allow the situation to drift and broader financing deals need to be negotiated.
To assist trustees in determining an appropriate policy for the elimination of existing deficits Standard & Poor’s is issuing guidelines which reflect the risk of sponsor failure and scheme maturity.
In principle, the deficit amortisation period should be no longer than the lesser of: • the average period to maturity, or • the period over which trustees can have an acceptable degree of confidence that the sponsor will be able to complete the full funding programme.
The average period to maturity (APM) is defined as the average period until pensions come into payment weighted by the value of the pensions.
For pensioners this period is zero as pensions are already in payment. For immature schemes the APM might imply a maximum amortisation period of 15 years while for mature schemes this might be 5 years.
Historic use of average working lives is becoming increasingly untenable as a benchmark for scheme funding owing to the accelerating maturation of schemes as well as their closure to new members.
The sponsor risk constraint reflects the financial strength of the sponsor and the trustee’s degree of confidence in the ability of the sponsor to avoid defaulting during the funding period.
For example, if a scheme sponsor is rated BBB and trustees believe they should be 95% confident that their sponsor will not default during the funding period, then, based on historic default evidence, the amortisation period should not exceed 10 years.
Similarly, if 97.5% confidence is required then this period would need to be shortened to 5 to 6 years and at 99% to 3 to 4 years. The table below illustrates the boundary where sponsor financial strength is most likely to curtail the amortisation period.
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