Healthcare impact of the pandemic could mean a £1bn annual reduction in contributions for FTSE100 pension schemes

LCP’s latest ‘Leading the Way report’ has highlighted that the wider healthcare impacts of the pandemic could reduce longer term contribution requirements for FTSE 100 companies by around £5bn, potentially corresponding to a £1bn reduction per year if efficient use can be made of contingent asset or contribution approaches.

Based on current evidence, LCP believes that that the likely medium to longer-term impact of the pandemic could result in falls in pension liabilities by 1-2% for typical schemes compared to pre pandemic levels. For FTSE100 schemes, LCP estimates this might correspond to around a £1bn p.a. reduction in annual contribution requirements for those schemes that are in deficit. However, due to continued uncertainty around the impact of the pandemic, achieving these reductions would likely require a proactive approach from sponsors and the continued evolution of contingent asset or contribution mechanisms.

The analysis also highlights that the pension schemes of around 50% of FTSE100 companies may already be fully funded using "low reliance" assumptions that could be consistent with the new longer term funding requirements we expect to see emerge from the Pensions Regulator later in the year. For these sponsors, we expect a key emerging goal will naturally be to find ways to complete journey plans, without significant additional or unexpected cash strain.

The report highlights there is room for optimism for scheme sponsors after the challenges of the pandemic, with markets finishing 2021 strongly and showing a combined FTSE100 company accounting surpluses for companies of £60bn at the start of 2022, and so far over 2022 the combined position has been resilient as rising bond yields have broadly offset the falling equity markets

Other findings and watch-outs for scheme sponsors highlighted in the report include:

• We predict that for many sponsors, a range of new challenges and uncertainties, including the impact of the Pension Schemes Act, will enhance business cases for insurance solution for their schemes.
• For companies now wanting to target buy-out, we predict that managing this journey in as cost-effective a way as possible will become a key strategic goal in coming years. This will need to encompass a range of innovative contingency planning, investment, and member option measures.
• While most schemes do now have a formal long-term target, for the largest schemes (above £1 billion in assets) around 50% are currently adopting a run-off approach. Smaller schemes are more likely to be currently targeting an insurance buy-out or superfund approach. Around one in six schemes (of all sizes) are yet to formalise their long-term strategies.
• Use of contingency mechanisms such as a letter of credit/surety bonds, escrow accounts or contingent contribution agreements can potentially support a level of investment risk being maintained and allow uncertainties around life expectancy trends to be navigated without “trapping” contributions if they are not ultimately needed.

Steven Taylor, Partner at LCP, commented: “There is room for optimism, with many of the UK’s largest schemes now fully funded using “low reliance” assumptions even before allowance is made for the potential impact of the pandemic on future life expectancy trends.

“Whilst this all appears good news for sponsors, these developments come with a fresh set of challenges and uncertainties, including the impact of the Pension Schemes Act 2021 and the new funding regulations. For some sponsors we predict this will enhance the business case for an insurance solution for their scheme.

In all cases, agreeing an appropriate long-term funding target between companies and schemes will be crucial and means that for all sponsors the pensions decisions they make today will likely have a profound influence on how their schemes evolve. In our experience, those sponsors who take a proactive approach with the scheme trustees around these discussions achieve better outcomes which align with their corporate strategy.”

Jonathan Pearson-Stuttard, Head of Health Analytics at LCP added: Life expectancies are among the most material assumptions used to assess pension scheme funding requirements. This means that for sponsors of schemes at or close to full funding, obtaining clarity in this area is likely to be vital to their pension strategies in the years ahead. In the early phases of the Covid-19 pandemic, many schemes took the view that there was insufficient longitudinal data to inform quantitative estimates of the impact of Covid-19 on their populations. It is notable that to date very few defined benefit schemes have moved to reflect the impact of the pandemic on their memberships."