Britain’s largest employers have poured roughly £175bn into their underfunded pension schemes over the past decade, according to a new report, but have made only a modest dent in shortfalls because liabilities are rising so much faster than asset values.
The report to be released Monday from consultant Mercer found that, despite this flood of new contributions from employers of FTSE 350 companies, the aggregate shortfall of that group narrowed only slightly from £75bn at the end of December 2002 to £73bn today.
The reason that the huge contributions made so little difference is because even though assets had risen, the value of liabilities have risen much faster.
While total liabilities were £357bn at the end of 2002, that had mushroomed to £574bn by the middle of 2012.
The sharp rise in liabilities has been driven by an equally sharp fall in interest rates. The two move in inverse relation to each other.
Adrian Hartshorn, consultant at Mercer, said part of the rise in liabilities has been the unexpectedly rapid rise in life expectancy at older ages. This, he said, accounts for about £50bn of the rise.
But it also may reflect some misplaced confidence that relative returns of equities and gilts markets would maintain the same relationship that they had over the previous two or three decades – when rates were high and stock markets entered their longest bull run in history.
Had schemes invested in index-linked gilts, these would have risen in value by as roughly much as liabilities over the decade to 2012.
However, while investing heavily in equities produced outsized returns in some years over the 2002-2012 period, they have not, on balance, outperformed enough to offset the surge in liabilities.
In recent years, pension scheme weightings in equities have fallen and those in bonds have risen.
However, only some of that reflects investment decisions. Part of it reflects market movements.
For decades, employers have been able to count on investment returns to cover a significant portion of the cost of pension promises.
During the 1980s and 1990s, these were sufficiently high to allow many employers to avoid making contributions at all. But since the bursting of the dotcom bubble, that has changed.
“Companies can chose to operate their plans in a very low risk way but there will be a very large upfront cost,” Mr Hartshorn added. “As it’s turned out, companies have chosen not to hedge the risk and that has cost them a lot of money.”
He noted that, even in the 1990s, yields on risk-free gilts were as high as 5 or 6 per cent.
When index-linked gilts were producing real yields of 2 per cent, they appeared to be poor value.
“People got used to relatively high equity returns and perhaps expected that to continue relative to government bonds,” he said. “Until people have actually lived through the downturn, they may be discounting it.”
Get alerts on Pensions crisis when a new story is published