After a strong year for shares, company pension schemes are back in surplus.
Here's some rare good news for members of private-sector final-salary pension schemes.
The gold standard of pensions
Final-salary pension schemes, long regarded as the 'gold standard' of pension funds, pay pensions based on length of service and salary at or close to retirement. Because of the income guarantees they provide to members, these defined-benefit plans have become increasingly more expensive to run.
Hence, over the past decade, the majority of private-sector final-salary schemes have been closed to new members, with some shutting down entirely. What's more, as pension deficits (the gap between assets and liabilities) have grown, insolvent schemes have ended up in the embrace of the Pension Protection Fund (PPF).
Great news for members
However, this week saw some good news from the PPF, which since July 2007 has produced a funding position for defined-benefit schemes on the second Tuesday of each month. Within the 7,342 schemes in its eligible universe (known as the PPF 7800 Index), the PPF has reported the first collective surplus since June 2008.
In total, the schemes monitored by the Pension Protection Fund recorded a surplus of £0.3 billion in March, versus a deficit of £15 billion in February. Here's how the deficit has improved over the past year -- a period during which the FTSE 100 has risen by roughly 45%:
The PPF 7800 Index of pension funds
* Differences in the last column are due to rounding
Just as it's said that a week is a long time in politics, a year is a long time in financial markets.
The risk rally which began in March 2009 has boosted share prices and increased yields on government bonds. The PPF reports that a 7.5% rise in equity markets boosts pension assets by around 4.0%, plus a 0.3% rise in Gilt yields reduces scheme assets by 1% but reduces scheme liabilities by 6%.
As you can see, rising share prices and Gilt (UK government bond) yields have helped to boost pension-fund assets at a faster rate than their liabilities have grown. Also, changes in the calculation of future pension costs have reduced liabilities by about £70 billion over the past year.
Some believe Gilt yields will continue to rise in the next few years, as more and more Gilts are issued to finance our growing national debt. This means scheme liabilities could continue to fall.
But many schemes are still in deficit
While this is good news for those private-sector workers lucky enough to belong to final-salary schemes, there is still a long way to go. Despite their collective surplus, most schemes are still in deficit.
Indeed, only 2,310 defined-benefit schemes (31.5%) are in surplus. What's more, the aggregate deficit for the remaining 5,032 schemes in deficit is £73 billion, although this is a huge improvement on their £253 billion total deficit recorded in March 2009.
Thus, there are still some very sickly -- and possibly insolvent -- occupational pension schemes out there.
Therefore, when looking at a company's books, make sure you establish the firm's pension situation. A large, underfunded final-salary pension scheme, whether closed or open, is sure to act as a drag on its sponsor's future profits. At the very least, a scheme with a large shortfall can expect to make major one-off and yearly top-ups in order to restore the scheme to profit over the coming decade.
Likewise, check a company's latest report and accounts to see whether the situation with its pension assets and liabilities has improved. In some cases, particularly pension funds with heavy exposure to equities, the fund is sure to be healthier than a year ago. This improvement may help to tip the value equation in favour of investing in some firms.
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