2007 was the start of the era of pension scheme surpluses

Despite a year of greater volatility, 2007 saw a significant overall improvement in pension scheme funding as accounting deficits gained 38bn over the year, which brings the last two years of gains to 70bn, according to Aon Consulting, a leading pension, benefits and HR consulting firm. Almost one half of UK schemes are now in surplus.

However, the overall picture for UK pension schemes is that it has been a year of mixed fortunes as volatility (depicted in Graphs 1 & 2 below) returned to levels not seen since 2002. The aggregate deficit improved from 40bn on the eve of 2007 (itself already a considerable improvement on the 72bn at the start of 2006) to a 2bn deficit at the end of December 2007.

The development of financially sophisticated tools for pension scheme management has also escalated during 2007, with a greater range of risk management options available for a wider number of schemes. It is expected that more companies will start using these tools in 2008 in an effort to mitigate against volatility.

Graph 1: Total FRS17/IAS19 surplus (or deficit) for the UKís largest 200 companies



By mid-February, the 40bn start of year deficit had fallen to 25bn before turmoil in Chinese equity markets prompted dramatic falls, which included 11bn of losses on February 27th, which was the largest single day of pension scheme losses since Aon Consultingís records began.

Markets soon recovered and, from the year low of 50bn in early March, the pension scheme deficit started a remarkable bull run. Rising equity markets and increasing bond yields improved the UKís pension scheme finances, culminating at 3:25pm on May 18th when the aggregate pension scheme returned to surplus for the first time. Although the time and date were largely symbolic, the return to surplus marked the start of a period when scheme finances dipped in and out of surplus for the rest of the year.

The tightening credit conditions in the summer, however, prompted large worldwide losses on equity markets. Confidence in the banking sector was at a low and pension scheme finances were adversely affected. It soon became apparent that the pensions accounting standards concealed most of the losses. As the market priced a higher risk of default on corporate bonds, so the benchmark measure of pension scheme liabilities fell, and pension schemes showed further gains.

Greater volatility
The 2007 calendar year has been extremely volatile. During the year, the aggregate deficit was 50bn in early March, yet at its peak it reached a surplus of 12bn in mid-September. Indeed, even in the three weeks between 21st November and 12th December, schemes improved from an aggregate deficit of 18bn to an aggregate surplus of 11bn.

Graph 2: Weekly volatility FRS17/IAS19 financial position for the UKís largest 200 companies



Commenting on the latest figures, Marcus Hurd, senior consultant and actuary at Aon Consulting, said: ì2007 has been a year of mixed fortunes. Pension scheme finances have improved dramatically but they have also experienced extreme levels of volatility.

ìFrom a long term perspective, 2007 will be remembered as the start of the era of pension scheme surplus. Although there may be pitfalls along the way, stronger funding measures are likely to mean that pension scheme accounting surpluses will persist.

ìShort term financial measures, however, have posed a real headache. Turmoil in the financial markets, whether emanating from China in February or the credit crunch that started in the summer, has produced dramatic swings. Over the year, the aggregate deficit has been as low as 50bn, while it has also reached a peak of 12bn. Such volatility has tested the resolve of even the most hardened long term investor.

ìWe have seen an increase in the sophistication of the financial tools available to pension scheme trustees and sponsoring companies. Development of the market for liability driven investment and diversified growth has made these solutions available to a wider spectrum of schemes. During 2008, we expect most schemes to take risk management seriously in a way that wasn't realistically available for the majority of schemes over the last few years.î

Comparative figures for the FTSE 100 companies since December 2006 are as follows:



Source: Aon Consulting