The gradual rally in the UK stock market at the end of 2003 has halved the black hole in the pension funds of the 100 leading UK companies, according to figures compiled by pension consultants Hewitt Bacon and Woodrow.
Three years of falling stock markets, culminating in an eight-year low in March 2003, led to huge deficits in company pension funds that some experts estimated equated to six per cent of the total market capitalisation of the FTSE 100.
The deficit represents the gap between the sums companies are liable to pay out in defined benefit pensions and the funds available in their pensions schemes to meet these liabilities.
Household names such as Royal Mail British Airways and BT were among those with the largest deficits, while the £2bn deficit in Rolls Royce’s pension fund reported in 2003 was more than the company was then worth on the stock market.
The falling markets meant that many companies have closed their final salary pension schemes (that guaranteed a proportion of final salary) and replaced them with money purchase schemes that depend on the returns made on the stock market. In these schemes, individuals shoulder the investment risk themselves
But following a rise in the FTSE of 13 per cent by the end of 2003, Hewitt Bacon and Woodrow estimate that the shortfall in company pensions schemes have halved £100bn in the middle of 2003 to £50bn at the year’s end.
Moreover, they say, if the FTSE rises above 5000 point, the pension deficits in many company funds would be wiped out entirely. But Raj Mody of Hewitt Bacon & Woodrow warned that relying on a stock market rally to solve the pensions crisis was a dangerous risk. "While assets are invested mainly in equities, schemes could still see a dramatic reversal of fortunes,” he said.
“The trustees of any scheme and the company which sponsors it need to get together to think about whether to lock into their current position, by investing in bonds, or whether to continue to take the risk with equities."
Another issue highlighted by Mr Mody is that most of us are living longer. "Improving life expectancy means that it will take longer for companies to pull their schemes out of their funding difficulties,” he said. “Any gains in the stock market, however welcome they are, will be lost. Pension schemes are not out of the woods yet.”
As a result, Mr Mo believes that employers will be forced to find radical solutions in future to solve the demographic challenge of an ageing population.
“Companies will need to offer much more flexible approaches around retirement to their employees, and allow older employees, in their 60s and maybe 70s, to continue working part time, say, to make up for future skill shortages."