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Aon: Pension Scheme deficits shrink by 25% during July

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Good performance of equities and rising corporate bond yields have pushed the aggregate accounting deficit to its lowest level this year according to Aon Consulting, the leading employee risk and benefits management firm.

According to Aon, the pensions deficit of the 200 largest privately sponsored DB schemes stood at £74bn at the end of July, a massive reduction from the £100bn deficit reported at the end of June. The announcement of the Government’s intention to reduce the level of statutory minimum pension increases that must be granted by UK pension schemes offers another opportunity to reduce pension deficits. However, the impact on different schemes could vary considerably depending on their rules and how the legislation is changed. The ultimate impact could be anywhere between nil and £150bn across UK pension schemes.

Aon has warned that the reduction in pension deficit, coming at the same time that schemes continue to close to accrual, creates risks for companies due to a forthcoming change relating to the treatment of surplus in pension schemes. Company representatives must be vigilant in order to ensure that they are not caught by this change, which could result in their balance sheet being substantially worsened. The new regulations are complex, but essentially require companies to account up front for whatever contributions they have committed to in a Recovery Plan. So, for example, if a company has agreed to pay £130,000p.a. for ten years then that could show as a liability of up to £1m in their accounts.

Companies can currently bypass this requirement, but that is set to change from 2011 unless Trustees agree to necessary rule changes. The combination of reducing deficits (both generally and due to CPI), together with reducing accruals, make the impact of the changes more onerous. Aon is therefore urging companies to contact their pension scheme trustees as soon as possible to ensure that the tthey are considering this issue.

Sarah Abraham, consultant and actuary at Aon Consulting, comments: “The changes to the treatment of surplus in UK pension schemes are now imminent, and could have some nasty implications. For many sponsors, if no action is taken now, balance sheet positions could increase substantially next year. “The coming changes will also create difficulties when companies are renegotiating contribution levels with pension scheme trustees. In our experience some employers are hesitant to make significant contributions if they have concerns about surplus being trapped in an overfunded scheme and the accounting implications will add further to their concerns.

“The Government’s plan to change the indexation on pension increases in the private sector is totally separate from the accounting changes, but is a clear example of why companies need flexiblity to reclaim pension scheme surpluses. We estimate that around half of companies could have their pension schemes pushed into accounting surplus if the change to CPI increases is able to be applied in full. “Accounting treatment aside, the changes in legislations on surpluses could create a genuine overfunding risk for employers – whether on an ongoing or accounting measure.”