Lower life expectancy assumptions and refinements to how companies convert the retirement benefits they expect to pay in future into a single liability number could knock up to £45bn off the pension deficits disclosed in FTSE350 companies’ accounts. Contributor Nicola Van Dyk, Director, Benefits – Willis Towers Watson.

This is on top of the £8bn reduction in deficits over 2017 that would have been expected by rolling forward the numbers in companies’ last published accounts to reflect how markets have moved over the past year.

Without any changes to how defined benefit pension liabilities are measured, deficits would have been relatively flat over 2017; there was no repeat of the turbulence seen after 2016’s EU referendum. Willis Towers Watson’s Asset Liability Suite tracking software – which provides daily estimates of pension asset and liability values – calculates that combined FTSE350 deficits would have fallen by £7.8bn over the year to 31 December 2017, to £119.6bn. Behind this modest aggregate change, some companies would have done much better: with global equities returning 14 percent, it was a year to be “on risk”. Willis Towers Watson expects that the deficits actually reported in companies’ updated accounts will be smaller than this.

First, most companies are expected to use the new CMI_16 model to project how long scheme members will live.  Switching to this model, which takes recent heavier-than-expected mortality as a starting point, reduces life expectancy by around 6 months for someone retiring in 20 years’ time. This reduces anticipated pension payments, potentially knocking up to £25 billion off FTSE350 deficits.

Second, to calculate a single liability number that can be compared with the market value of pension plan assets, companies need to discount back the pension payments that they anticipate their schemes making over many years.

Accounting standards require companies to base discount rates on high quality corporate bond yields. However, this requires some judgement because AA sterling-denominated corporate bonds have shorter durations than most companies’ pension liabilities.  Technical changes which companies have discussed with auditors concern which bonds to look at and how to derive longer-term yields from market rates.  Not all companies will make changes here but the overall impact could still be to reduce the aggregate liabilities disclosed to investors by up to a further £20 billion.

Commenting on the findings, Nicola Van Dyk, director, Benefits, at Willis Towers Watson, said: “Buoyant equity markets provided a fair wind for pension scheme assets in 2017. Overall, our Asset Liability Suite tracking software projects that pension assets rose by about 5.5 percent – a couple of percentage points faster than liabilities would have done even without changes to how these are calculated.

“At the same time, death rates have been higher than predicted, and this has allowed companies to budget on the basis that pension scheme members won’t live quite as long as they used to expect.

“Unlike reductions in life expectancy, higher discount rates do not shrink the cash payments that companies anticipate their schemes making to pensioners in future – but they do mean that each £1 of future pension can be given a lower value today.  The scale of the pension promises that large employers have entered into means that small technical changes can make a meaningful difference to the pension numbers on their balance sheets.”

The Pension Deficit Index is compiled using Willis Towers Watson’s Asset Liability Suite, a web-based software platform for pension scheme trustees, sponsors and investment specialists. It enables real time tracking of funding levels and risks, helps plan and monitor strategy and provides key management and reporting information at the touch of a button.