Pension deficits shrink by more than 90% in a year

UK pension deficits have shrunk by more than 90 per cent during 2007, with the average funding level of company schemes now at 99 per cent, according to the consultancy Aon.

The combined deficit of the UK's 200 largest final salary pension schemes has fallen from 42bn to 3bn over the 11 months of the year so far, while the average funding level has increased from 92 to 99 per cent on an FRS 17 basis.

Although some of the gains can be attributed to companies making one-off payments into schemes, the main driver has been the sharp improvement in corporate bond yields over the past few months, on the back of the credit crunch. Yields have increased as the market has priced in a greater risk of UK companies defaulting.

Pension deficits have diminished rapidly over the past few years, as new regulations have put pressure on companies to repair holes in their schemes. Those who have not taken decisive action have ended up penalised by having to pay higher levies to the Pensions Protection Fund.

By the end of November, Aon said 49 per cent of the UK's 200 largest pension funds were in surplus. "Considerable gains are likely for the second consecutive year, which will ease the short-term balance sheet pressures for company finance directors," said Marcus Hurd, senior consultant and actuary at Aon Consulting. "Volatility persists, however, and companies are advised to review pension scheme risk while the accounting balance sheet remains strong.

"Ironically, the second year of gains has been driven by the market pricing higher credit risk on corporate bonds. Critics of pensions accounting standards will argue that these gains are superficial, but the reality of company reporting is that these gains will be reflected in company accounts."

Although Aon's figures show a marked improvement in the funding of defined benefit pension schemes, they are only based on the FRS 17 accounting mechanism, which does not represent the true costs of winding up a pension scheme should its sponsoring employer go bust. Using a full buyout valuation which represents the cost of buying annuities to guarantee each scheme members' pension the UK's 200 largest schemes would still be many billion pounds in deficit.