British pension funds face €109bn black hole

Britain's company pension funds face a £70 billion sterling (€109 billion) black hole in their funding under new accounting rules, according to a new report.

But the report, from consultant Watson Wyatt, said deficits could be wiped out if trustees keep faith with stocks, economic growth is in line with projections and share perform accordingly.

Two years of falling stock markets have wiped billions of pounds from the value of British company pension funds, leaving the value of their assets under accounting rule FRS 17 sliding deeper and deeper into the red when measured against the cost of future pensions.

According to Watson Wyatt, Britain's top 100 companies faced a funding shortfall of £35 billion at the end of July while the total deficit could be as high as £70 billion for all British companies.

"Approaching 90 per cent of companies will currently have an FRS 17 deficit," said Mr John Ball, partner at Watson Wyatt.

The reason for the big slide in funding levels is that British pension funds invest around 64 per cent of their assets in equities.

Falling markets have cut the value of investments, while long-term liabilities, which are measured against the return on corporate bonds, have risen.

Companies such as engineering firm GKN , which last week said it had a big shortfall in its pension fund, are having to inject funds to plug the gap.

But it may not all be doom and gloom.

Some critics of FRS 17 say the numbers it produces are essentially meaningless. Because pension funds invest heavily in equities, funding levels rise when stock markets rise and fall when they drop.

Taking a "snapshot" when markets are down is no more accurate a reflection of the long-term funding position than measuring levels when markets are up.

Watson Wyatt's report makes a second point. With dividend yields on British stocks averaging 3.5 per cent and assuming stock markets rise in line with long-term projections for the country's economy of 2.5 per cent above inflation, the return on equities should be around six per cent in future.

Assumptions used in FRS 17 are 2 per cent to 3 per cent lower than this, meaning if pension funds do achieve the higher level of return, the £70 billion deficit would be wiped out in around 10 years, Watson Wyatt said.

However, this depends on pension funds maintaining faith in equities.

Many may not. Given recent stock market performance many pension funds may want to raise the proportion of less risky bonds in their portfolios reducing the expected levels of long-term return.

However, lower expected returns from bonds would raise the cost of pension provision and hit profits at a time when many firms are complaining they cannot afford to run traditional final salary schemes.

A switch by FTSE companies of 20 per cent from equities to bonds could reduce annual profits by around one billion pounds in total, according to the report.

"It is a trade off between staying in equities with higher expected return but greater volatility... and higher cost and less risk from investing in bonds."

- (Reuters)