LCP ACCOUNTING FOR PENSIONS 2011 FTSE 100 companies have nearly 400 billion of UK pension liabilities. This report looks at the steps taken to manage

Transcription

1 LCP ACCOUNTING FOR PENSIONS 2011 FTSE 100 companies have nearly 400 billion of UK pension liabilities. This report looks at the steps taken to manage those liabilities and to ensure that members receive their promised benefits.

2 2 We would like to thank those from LCP who have made this report possible: Rachel Banham Clare Barley Jennie Bell Nick Bunch Rachael Casey Richard Chini Jeremy Dell Catherine Drummond Beth Dunmall David Everett Hannah Gillinson Anika Grant-Braham Peter Grove Colin Haines Steve Hodder Stephen Hunt Emma Ingham Stuart Levy Daniel Lewington Emma Mackenzie Tim Marklew Donna Matteucci Jenny Pike Daniel Potter Martin Robinson Rebeccah Robinson Bob Scott Martin Slack Laura Strachan James Trask Rachel Walton Tim Weir David Wong Min For further information about UK issues please contact Bob Scott or Nick Bunch in our London office. For international issues contact Colin Haines, Richard Chini or alternatively the partner who normally advises you. This report may be reproduced in whole or in part, without permission, provided prominent acknowledgement of the source is given. The report is not intended to be an exhaustive analysis of IAS19. Although every effort is made to ensure that the information in this report is accurate, Lane Clark & Peacock LLP accepts no responsibility whatsoever for any errors, or the actions of third parties. Information and conclusions are based on what an informed reader may draw from each company s annual report and accounts. None of the companies have been contacted to provide additional explanation or further details. View a full list of our services at Lane Clark & Peacock LLP August 2011

3 3 LCP Accounting for Pensions 2011 p4 1. Main findings p6 1.1 Deficits reduce but companies must still manage substantial liabilities p6 1.2 Accounting changes will mean lower headline profits for many companies p7 1.3 RPI to CPI good news for companies, but bad news for pension scheme members p7 1.4 Substantial contributions still being paid p8 1.5 Alternative funding strategies on the increase p8 1.6 Defined benefit pension provision continues its decline p9 1.7 Further de-risking p Overseas schemes of FTSE 100 companies p12 2. Summary of UK findings p Introduction p Pension scheme deficits p Reductions in liabilities - the change from RPI to CPI p Pension scheme funding remains strong p Alternatives to cash funding p The continued decline of defined benefit pensions p Pension schemes continue to de-risk p34 4. Accounting standards for pensions p Reduced profits for most companies p Removal of corridor will hit some balance sheets p Strengthening of disclosure requirements p Further changes still possible p42 5. LCP s analysis of FTSE 100 IAS19 disclosures p Introduction p Analysis of results p Key assumptions p60 6. Non-UK schemes of the FTSE 100 p Introduction p Key findings p Analysis of disclosures p Deficit and risk reduction measures p Non-UK pension scheme asset allocation p Consistency of assumptions p69 Appendix 1 FTSE 100 accounting disclosure listing p73 Appendix 2 FTSE 100 accounting risk measures p28 3. Developments in UK pension provision p The decline of final salary schemes p De-risking p Public sector pension provision

4 4 Content p4 1. Main findings p6 1.1 Deficits reduce but companies must still manage substantial liabilities p6 1.2 Accounting changes will mean lower headline profits for many companies p7 1.3 RPI to CPI good news for companies, but bad news for pension scheme members p7 1.4 Substantial contributions still being paid p8 1.5 Alternative funding strategies on the increase p8 1.6 Defined benefit pension provision continues its decline p9 1.7 Further de-risking p Overseas schemes of FTSE 100 companies

5 Bob Scott Partner LCP It is now very rare for companies to offer membership of a defined benefit scheme to new employees. From 2012, as companies face the cost and administrative complexity of auto enrolment, further downgrading of existing schemes is likely. In the short term, this may help the companies finances but, in the longer term, many people could find that they simply cannot afford to retire. Main findings

6 6 LCP Accounting for Pensions Main findings 400bn FTSE 100 companies face the challenge of managing nearly 400 billion of UK IAS19 liabilities. 1.1 Deficits reduce but companies must still manage substantial liabilities LCP estimates that the combined UK IAS19 deficit of FTSE 100 companies has more than halved since our report last year, reducing from 51 billion in June 2010 to 19 billion at the end of June We estimate that this reflects a total value of liabilities of 398 billion, compared to 379 billion of assets held by pension schemes sponsored by FTSE 100 companies. In the last 12 months, many companies have seen their pension liabilities reduce as the Consumer Prices Index ( CPI ) replaced the Retail Prices Index ( RPI ) as the reference for pension indexation. Asset values have risen over the year and sponsoring employers have continued to pay very substantial contributions into their pension schemes. Despite general economic uncertainty, UK corporate bond yields, that drive IAS19 valuations of pension liabilities, have remained relatively stable. This has meant that disclosed liability values have also remained fairly stable over the last year. Therefore, 2010/11 has been a relatively benign period for pension schemes. However, the challenge remains of managing nearly 400 billion of UK IAS19 liabilities and ensuring that members receive their promised benefits. Further details and analysis can be found in section Accounting changes will mean lower headline profits for many companies Changes to IAS19, which will come into force in 2013, have been in the pipeline for some time now. In June 2011 the International Accounting Standards Board published its final version of the new pensions accounting standard. This confirmed earlier proposals, the most significant of which is the alignment of the expected return on assets and interest cost items. This change will result in many companies reporting lower profits than would previously have been the case because they are no longer allowed to reflect the fact that the assets in their pension scheme are expected to generate a higher return than corporate bond yields. Based on companies most recent accounts, this will mean lower disclosed profits for the vast majority of FTSE 100 companies that sponsor defined benefit pension schemes.

7 LCP Accounting for Pensions Main findings 7 To illustrate this, if the revised standard had applied at 31 December 2010, then we estimate that the reduction in disclosed 2010 profits for BP, Lloyds Banking Group and Barclays would have been 310 million, 190 million and 165 million respectively, due to this change. We estimate the total impact across the FTSE 100 could be a 3 billion reduction in profits. Further details and analysis can be found in section 4. 3bn We estimate the total impact across the FTSE 100 of the updated IAS19 could be a 3 billion reduction in reported profits. Main findings 1.3 RPI to CPI good news for companies, but bad news for pension scheme members Companies have only recently started to disclose the impact of the change from RPI to CPI in their accounts, but, by 31 December 2010, many were showing a one-off decrease in the value of their pension liabilities. In some cases, this reduction has been significant BT has shown a massive 3.5 billion decrease in liabilities in its 2011 accounts due to this change. Whilst this is good news for company balance sheets, it is only a consequence of providing lower benefits to scheme members. If CPI were to average 0.75% pa less than RPI, a pensioner retiring at age 60 on 10,000 pa would see their benefit eroded by nearly 1,200 pa in today s terms by the time they reach age 75. The difference is even greater for a deferred pensioner whose pension has yet to come into payment; a 45 year old expecting RPI linkage up to retirement and in payment could lose around a quarter of the value of their pension. As the effect of the Government s announcement has become clear, we have seen protests by several pensioner groups as well as the resignation of three of the trustees of one of the British Airways pension schemes due to the decision to move future increases in line with CPI inflation. Not all companies are affected to the same degree as the impact depends on the wording of each individual scheme s rules. Further details and analysis can be found in section Substantial contributions still being paid Companies have continued to pay substantial pension contributions, with 17 billion being paid into pension schemes of FTSE 100 companies during Of this, around 11 billion went towards meeting deficits rather than paying for future benefit accrual. Further details and analysis can be found in section 2.4.

8 8 LCP Accounting for Pensions Main findings 1.5 Alternative funding strategies on the increase Companies are increasingly finding innovative ways, other than direct payment of cash contributions, to provide security to trustees, or to fund pension scheme deficits. BT, InterContinental Hotels, Invensys and Whitbread have all made arrangements whereby additional payments may be made to their pension schemes depending on the performance or activities of the business. An emerging trend is for companies to enter into partnerships with their pension scheme trustees. These involve transferring assets often property, but including other assets such as maturing whisky or royalty rights - into the newly created partnership. Those assets generate an income for the pension scheme and provide collateral in the event of insolvency, but revert back to the sponsoring employer either once the scheme is fully funded, or after a pre-determined period. Along with several other companies, GKN, Kingfisher, Lloyds Banking Group and Whitbread all disclosed having entered into a partnership with their pension scheme trustees during 2010 or early The use of a partnership arrangement can have several advantages for both trustees and employers. However, HM Revenue & Customs has expressed concern that, in some cases, these partnerships may be providing employers with unintended levels of tax relief and, at the end of May 2011, published a consultation document on how this might be limited. Further details and analysis can be found in section During 2010, 15 more FTSE 100 companies closed their final salary schemes to future accrual or announced that they plan to do so. 1.6 Defined benefit pension provision continues its decline During 2010 a number of FTSE 100 companies made changes to reduce the level of pension benefits being built up by employees. Many have limited the rate of increase in pensionable salary in recent years and this continued in 2010, with AstraZeneca, Lloyds Banking Group and United Utilities all introducing caps on pensionable salary increases. Taking this a step further, 15 more FTSE 100 companies, including Aviva, Unilever and Vodafone, closed their final salary pension schemes to all future benefit accrual in 2010, or announced that they plan to do so in the near future. In a few cases defined benefit provision will continue on a career average basis. Other legislative changes on the horizon, including auto-enrolment and the proposed end to contracting-out of the state pension system for defined benefit pension schemes, are likely to mean more closures to future benefit accrual.

9 LCP Accounting for Pensions Main findings 9 It is now very rare for companies to offer membership of a defined benefit pension scheme to new employees. During 2010, BP closed its UK pension scheme to the majority of new joiners and Imperial Tobacco closed the defined benefit section of its pension schemes to all new entrants. Further details and analysis can be found in section 2.6 and section Further de-risking With more pension schemes closed to future accrual, sponsoring employers and trustees are looking increasingly towards the ultimate end game for their pension scheme, and acting to reduce the level of risk the scheme poses to their business. This year saw a continuation of the trend for pension scheme assets to be switched out of equities and into bonds, which more closely match the benefit payments due. For companies with 31 December year-ends, the average proportion of assets invested in equities reduced from 45% to 42% over This is despite the fact that equities outperformed bonds and, if no action had been taken, the proportion in equities would actually have increased. A few companies in particular witnessed significant de-risking of their pension scheme s investment strategy during 2010, with Centrica and Standard Life both moving more than 15% of pension scheme assets out of equities and into bonds. Other companies have established strategies under which assets are automatically switched into bonds on pre-agreed triggers to lock in favourable asset outperformance. Such switches out of equities and into bonds could ultimately lead to a drag on the performance of UK equities. There were also several notable risk transfers during Next, British Airways, IMI and GlaxoSmithKline all purchased policies designed to insure against the investment, inflation and longevity risks for a group of their pensioners during We expect to see an increase in the level of this type of activity during 2011 given the improvement in funding levels and current competitive levels of insurer pricing. Both of these factors make it more likely that a transaction can take place without the need for a cash injection from the company. Further details and analysis can be found in section 2.7 and section 3. Main findings

10 10 LCP Accounting for Pensions Main findings 1.8 Overseas schemes of FTSE 100 companies Overseas pension and other post-retirement liabilities remain significant for many FTSE 100 companies. We estimate that, under IAS19, FTSE 100 companies have in excess of 80 billion of overseas pension and other post-retirement liabilities. As in the UK, a number of FTSE 100 companies have disclosed steps taken during 2010 to control pension risks and reduce pension deficits in their overseas schemes. Many companies provide healthcare benefits to retired former overseas employees. FTSE 100 companies valued such liabilities at 10 billion, of which 9 billion was for US schemes. Falling discount rates and changes to mortality tables have acted to push up IAS19 pension liabilities in many countries. Many companies adopt different assumptions for calculating their IAS19 liabilities overseas from those that they use in the UK. It is not always clear that such different treatment is justifiable. Further details and analysis can be found in section 6.

11 Bob Scott Partner LCP During 2010, pension schemes of FTSE 100 companies continued to reduce the proportion of their assets held in equities. Many have established strategies under which assets are automatically switched out of equities into bonds on pre-determined triggers. Such switches could ultimately lead to a drag on the performance of UK equities. Section Main findings heading

12 12 Content p12 2. Summary of UK findings p Introduction p Pension scheme deficits p Reductions in liabilities - the change from RPI to CPI p Pension scheme funding remains strong p Alternatives to cash funding p The continued decline of defined benefit pensions p Pension schemes continue to de-risk

13 Bob Scott Partner LCP The change from RPI to CPI has meant reductions in pension liabilities for many FTSE 100 companies - with BT showing the biggest impact billion. Collectively, this is good news for companies balance sheets but it only reflects the consequence of providing lower benefits for retired employees. Summary of UK findings

14 14 LCP Accounting for Pensions Summary of UK findings 2.1 Introduction This section provides an insight into the disclosure of pension scheme costs in companies accounts, comparing the different practices adopted by the largest UK companies and highlighting the financial implications. By analysing their pension disclosures we aim to measure the exposure that companies have to their pension liabilities and deficits, particularly in the context of their market capitalisations, and we identify the steps that companies are taking to address their pensions issues. FTSE 100 companies scrutinised This report covers 83 of the FTSE 100 companies, analysing annual reports based on FTSE 100 constituents as at 31 December companies were excluded from this report as they did not sponsor a material funded defined benefit pension scheme. British Airways (now International Airlines Group, following the merger with Iberia) produced two sets of accounts during 2010; unless otherwise stated we have taken figures from their main report covering the year to 31 March A full list and summary details of the 83 companies key pension disclosures are set out in appendix 1. We have also included updated analysis on the 25 companies who published accounts before 30 June 2011 for accounting years up to 2 April All the UK companies analysed have reported under international accounting standards (IAS19 for pension costs) as required under EU regulations. The information and conclusions of this report are based solely on detailed analysis of the information that companies have disclosed in their annual report and accounts and other publicly available information. We do not approach companies or their advisers for additional information or explanation.

15 LCP Accounting for Pensions Summary of UK findings Pension scheme deficits We estimate that, under the accounting standard IAS19, the aggregate FTSE 100 pension deficit as at 30 June 2011 stood at 19 billion, comprising 398 billion of liabilities, offset by 379 billion of assets. This is less than half of the estimated deficit at 30 June 2010, reported last year. The chart below shows how the position has developed over the past five years. Our figures include unfunded pension promises but exclude, where possible, the overseas pension schemes sponsored by FTSE 100 companies and any employee benefits other than pensions. We have included a separate analysis of overseas arrangements in section 6. 19bn The aggregate FTSE 100 pension deficit as at 30 June 2011 stood at 19 billion, compared with 51 billion in June Estimated IAS19 position for UK schemes of FTSE 100 companies 20 0 Jun 2006 Dec 2006 Jun 2007 Dec 2007 Jun 2008 Dec 2008 Jun 2009 Dec 2009 Jun 2010 Dec 2010 Jun 2011 Summary of UK findings -20 billion Source: Office for National Statistics - Retail and Consumer Prices Indices (all items) This reduction in the deficit primarily reflects positive asset returns over the period, the change to CPI (discussed further in section 2.3) and the deficit reduction contributions being paid by FTSE 100 companies into their pension schemes (discussed further in section 2.4).

16 16 LCP Accounting for Pensions Summary of UK findings Bond yields Under IAS19, liabilities are measured by reference to yields on high quality corporate bonds, which have remained relatively stable since the start of This contrasts with the experience of the previous two years, when yields - and hence liability valuations - were considerably more variable. The majority of companies in our survey had reporting dates of 31 December At the end of 2010 the range of yields on corporate bonds was very narrow, particularly at longer durations, as illustrated below. As a result there was relatively little variance in the discount rates adopted with 80% of companies adopting a discount rate of between 5.4% pa and 5.5% pa. AA-rated corporate bond yields (% pa) 15% 31 December December 2010 Yield (% pa) 10% 5% 0% Duration (years) Source: Merrill Lynch

17 LCP Accounting for Pensions Summary of UK findings Reductions in liabilities - the change from RPI to CPI On 8 July 2010 the pensions minister announced that the inflation measure applying for statutory increases in occupational pension schemes would change from the Retail Prices Index ( RPI ) to the Consumer Prices Index ( CPI ). Due to the different construction of the CPI and RPI inflation measures, CPI inflation is expected to be around 0.5% pa to 1.0% pa lower than RPI inflation over the long-term, although this is not necessarily the case in any one year. A change to CPI inflation for the purposes of increasing pensions is therefore likely to represent a significant decrease in the overall future payments that a pension scheme expects to make. Historic differences in CPI and RPI inflation are shown in the graph below. Annual increase in Retail and Consumer Prices Indices (% pa) 6% 4% Annual RPI inflation Annual CPI inflation Summary of UK findings Increase (% pa) 2% 0% Jun 05 Jun 06 Jun 07 Jun 08 Jun 09 Jun 10 Jun 11-2% Source: Office for National Statistics - Retail and Consumer Prices Indices (all items) The impact of the change varies by pension scheme as it depends on the interaction of the scheme rules - which in many cases will have been drafted decades ago - with the change in legislation. This has therefore created a small print lottery with some companies witnessing a significant fall in their pension scheme s liabilities and some seeing no change. The most common impact has been for pension increases in payment to be unaffected but for deferred pension revaluation to move to a CPI base. In its revised July 2011 impact assessment, the Government has estimated that, across all UK pension schemes, the change to CPI will reduce the current value of members benefits by 73 billion.

18 18 LCP Accounting for Pensions Summary of UK findings Given the timing of the Government s announcement, most companies in our survey had not yet reflected the change to CPI inflation in their 2010 accounts. Of the 48 companies disclosing figures for UK defined benefit pension schemes at 31 December 2010, 20 of these (42%) allowed for a change to CPI inflation for some increases to benefits. Other companies, such as HSBC, Prudential and TUI Travel illustrated the effect of such a change, but did not allow for this in their 2010 accounts given continuing uncertainty over whether the change to increases would apply in their pension schemes. Of the 2011 accounts that we have analysed, 11 further companies have allowed for the impact of the change to CPI. The graph below illustrates the financial impact of the move to CPI inflation, where this has been quantified in companies December 2010 and March 2011 accounts. Reduction in IAS19 liabilities due to move to CPI inflation - December 2010 and March 2011 year-ends ( million) 3 December 2010 March 2011 Number of companies under 5 5 to 9 10 to to to to or over 3.5bn The financial impact for BT of the change to CPI has been a 3.5 billion reduction in liabilities in its March 2011 accounts. The financial impact for BT has been by far the largest, with a massive 3.5 billion reduction in liabilities disclosed in their March 2011 accounts. This was due to a change to CPI for all increases in deferment and for increases in payment for members who joined the pension scheme prior to April British Airways disclosed a gain of 770 million in its accounts covering the nine months to 31 December The next largest gains were for BAE Systems and Tesco, which disclosed deficit reductions of 348 million and 270 million respectively in their December 2010 and February 2011 year-end accounts. We expect to see more significant reductions in liabilities due to the move to CPI inflation disclosed in 2011.

19 LCP Accounting for Pensions Summary of UK findings 19 Of course, where companies are seeing a significant reduction in their obligations to current and former employees, pension scheme members are losing out through lower expected future benefits. If CPI were to average 0.75% pa less than RPI, a pensioner retiring at age 60 on 10,000 pa would see their benefit eroded by nearly 1,200 pa in today s terms by the time they reach age 75. The difference is even greater for a deferred pensioner whose pension has yet to come into payment; a 45 year old expecting RPI linkage up to retirement and in payment could lose around a quarter of the value of their pension. Towards the end of 2010 and into 2011, we have seen several pensioner groups expressing their anger where a change to CPI inflation has resulted in lower increases to their pensions than would previously have been the case. The most notable case within the FTSE 100 was British Airways where, in addition to pensioner protests, three pension scheme trustees have resigned over the decision to index pensions in line with CPI inflation in future. In contrast, we have not seen the same scale of protests where non pensioners are the only members affected we suspect this is largely due to the fact that, for deferred members, many years from retirement, the change is not immediately apparent. Summary of UK findings Whereas, in the private sector, the change to CPI appears mainly to have affected deferred pensioners, most public sector pensioners will have their payments indexed in line with the CPI in future. This is one of a number of factors that have led to protests from public sector employees and their trade unions. Interestingly, it was reported recently that the Bank of England pension scheme would continue to index pensions in line with the RPI. The change to CPI, although more widespread in the public sector, is not universal. 2.4 Pension scheme funding remains strong In last year s Accounting for Pensions publication, we reported that companies had paid record contributions into their defined benefit pension schemes over The amount paid in 2010 is marginally lower than last year s record, but still very substantial, with a total of 17 billion paid into defined benefit pension schemes of FTSE 100 companies during the year.

20 20 LCP Accounting for Pensions Summary of UK findings Of these contributions, around 11 billion went towards reducing deficits rather than providing future benefit accrual for current employees. The fact that only just over a third of payments went towards new benefits for current employees illustrates the extent to which defined benefit pension schemes are now largely a legacy issue for FTSE 100 companies. The largest contribution made during 2010 was 2.1 billion, paid by HSBC three and a half times the amount they paid in 2009, and the result of a special contribution of 1.76 billion to accelerate the removal of the pension scheme s deficit. Several companies reported that they have accelerated deficit payments in 2010, possibly in some cases to take advantage of higher rates of tax relief applying in the 2010/11 tax year. The only other company to pay more than 1 billion during 2010 was Royal Dutch Shell. Ten companies - 3i, BAE Systems, British Airways, BT, IMI, Invensys, GKN, Lloyds Banking Group, Serco and Wolseley - all paid more into their pension schemes than they distributed to shareholders. The chart below shows how company payments to pension schemes have changed since Employer contributions to pension schemes ( billion) 25 Deficit contributions (defined benefit) 20 Employer service cost (defined benefit) Employer defined contribution costs billion Contribution rates to defined benefit schemes are typically set every three years and as a result we would expect to see some stability in contribution levels over short periods.

21 LCP Accounting for Pensions Summary of UK findings Alternatives to cash funding As well as paying additional contributions into their pension schemes, companies are increasingly finding innovative ways of plugging pension scheme deficits or providing security to pension scheme trustees. 3i, British American Tobacco, Experian, Reckitt Benckiser, Rio Tinto, Scottish & Southern Energy, Smith & Nephew and Standard Life all disclosed having company guarantees in place for some or all of their defined benefit schemes. When structured correctly, cross-company guarantees can also help to reduce the annual levy payable by the pension scheme to the Pension Protection Fund ( PPF ). AstraZeneca, BAE Systems, Man, Smiths and TUI Travel all disclosed having paid additional contributions to an escrow account or separate trust, that would then be payable to the pension scheme on the occurrence of certain events, such as insolvency. British Airways disclosed that its pension scheme has access to letters of credit totalling 294 million which are secured on aircraft. Similarly, the Centrica pension scheme has been granted a charge over the Humber power station and the Rexam pension scheme has a charge over canning facilities and machinery, enforceable in the event of a default on contributions to the scheme or a material decline in the strength of the employer s covenant. 28 The number of FTSE 100 companies disclosing some form of alternative funding or security for their pension scheme. Summary of UK findings In our analysis of 2010 accounts we have seen an increasing number of companies pledging additional pension contributions that are dependent on the performance or activities of the business. Whitbread has promised that the pension scheme will participate in any increase in ordinary dividends in excess of RPI as well as the right to consultation before any special distribution can be made. Invensys has said that at least 8% of the proceeds of any business sale exceeding 1 million will be paid into the pension scheme. InterContinental Hotels has agreed that 7.5% of the net proceeds of any hotel disposals will be paid into the pension scheme with additional payments dependent on the growth in the group s earnings above specified targets. BT has agreed that one third of any proceeds from disposals and acquisitions in excess of 1 billion during any 12-month period will be paid into its pension scheme. In addition, BT has promised that contributions to the pension scheme will be at least as large as payments made to shareholders over the three years to 31 December 2011.

22 22 LCP Accounting for Pensions Summary of UK findings A relatively new method of funding pension schemes has been for companies to enter into a newly created partnership with their pension scheme trustees. Marks & Spencer were one of the first companies to set up such an arrangement but these have now also been utilised by Lloyds Banking Group, Diageo, Tesco, Sainsbury s, Whitbread, GKN, IMI, Kingfisher and TUI Travel. The typical operation of a partnership arrangement is as follows: 1. Specific assets of the company are transferred into the newly created partnership. 2. The company makes a one-off contribution to the pension scheme, which is then invested in the partnership in return for the right to income generated by the partnership assets. In some cases, the right to receive this income may be contingent on other events for example, the level of dividends paid by the company. 3. The partnership is structured so that the partnership assets would transfer into the pension scheme on the sponsoring employer s insolvency. 4. After a specified period the assets in the partnership revert to the company, possibly with a further contingent payment from the partnership to the pension scheme to ensure that the scheme is fully funded. For the pension scheme this arrangement provides a regular income and additional security against the sponsoring employer s insolvency. For the employer, this type of arrangement has even more advantages: There is no requirement for an up front cash contribution, yet the pension scheme can place a value on the future income stream. Accelerated tax relief can be received on the future payments to the pension scheme from the partnership. The period over which the scheme s deficit is removed can be longer than would normally be acceptable for direct cash contributions. The arrangement can be structured to avoid the risk of a trapped surplus. There may be a reduction in the scheme s PPF levy.

23 LCP Accounting for Pensions Summary of UK findings 23 However, HM Revenue & Customs has recently expressed concern that, where income to the pension scheme is contingent, rather than guaranteed, companies may be receiving excessive tax relief due to the interaction of accounting and tax rules. In May 2011 it launched a consultation on how this can be limited. It is unclear how much employers have been incentivised to enter into such arrangements by the unintended tax breaks, but some may find that they end up with lower levels of tax relief than anticipated. In most cases, companies have sold property to the partnership which is then leased back to the company, with the rental income generated by the partnership being payable to the pension scheme. However, other types of asset are suitable. For instance, as was widely reported last year, Diageo has transferred whisky into a partnership with its pension scheme trustees, which generates an income for the pension scheme as it matures and is sold back to the company. We are now also seeing companies transferring intangible assets to partnerships. As well as property, GKN sold the licence over its trademark and royalty rights to its pensions partnership. TUI Travel followed along the same route, transferring the brand rights to Thomson and First Choice with the company paying 1.65% of annual turnover to use these. Summary of UK findings Whilst intangible assets may provide the pension scheme with a similar income to assets such as property, they do not provide the same level of security. In this case, the time at which the pension scheme needs to rely on the security of such assets when the sponsoring employer is facing insolvency is exactly when assets such as the company s trademark and royalty rights may well be worth very little.

24 24 LCP Accounting for Pensions Summary of UK findings 2.6 The continued decline of defined benefit pensions The level of defined benefit pension provision in the UK continues to decline with a recent NAPF survey revealing that over the last year the number of final salary pension schemes that have closed to all future benefit accrual increased from 7% to 17%. This trend has been evident for FTSE 100 companies with five Aviva, Barclays, Compass, IMI and Vodafone reporting that they have ceased all accrual of defined benefit pensions during For some of these companies the removal of the link to final salaries has resulted in a significant reduction in liabilities. Aviva, Barclays and IMI disclosed gains of 286 million, 189 million and 15.1 million respectively. A further five FTSE 100 companies 3i, Alliance Trust, G4S, Man and Schroders have announced that they plan to cease future benefit accrual during 2011 and Severn Trent has announced it is looking to close to accrual in Although not ceasing all defined benefit provision, a number of companies have made changes to their scheme s benefit design to reduce the rate at which defined benefit pensions and the associated risk continue to build up. Capita, GKN and Johnson Matthey have all changed final salary benefit accrual to a career average revalued earnings (CARE) basis. Under a CARE scheme members receive a percentage of their average earnings, increased with inflation to retirement, rather than a percentage of their final pay. Removing the link to final salaries has resulted in a 12.6 million accounting gain for Capita and 68 million gain for GKN. Johnson Matthey did not disclose the amount saved through this benefit change. Similarly, Unilever has announced plans to cease final salary accrual, with members receiving a combination of CARE and defined contribution benefits going forward. RSA, United Utilities and TUI Travel have all introduced caps on pensionable pay. AstraZeneca has gone one step further and frozen pensionable pay with effect from June 2010, resulting in a $693 million ( 437 million) gain being disclosed in their 2010 accounts. This change to benefits resulted in a series of strikes by staff at their Macclesfield factory during September RSA, in common with HSBC, has also increased members retirement ages. Resolution and United Utilities have reduced rates of benefit accrual, whilst at the same time increasing the level of required contributions from employees.

25 LCP Accounting for Pensions Summary of UK findings 25 It is now very rare for companies to offer new employees defined benefit pension provision. During 2010 BP closed its UK pension scheme to the majority of new joiners and Imperial Tobacco closed the defined benefit section of its pension schemes to all new entrants. 2.7 Pension schemes continue to de-risk With the vast majority of pension schemes closed to new members, and an increasing number closed to all future benefit accrual, many defined benefit pension schemes are now largely a legacy issue, affecting a declining proportion of a company s current workforce. We are therefore seeing companies, in conjunction with pension scheme trustees, looking to reduce or remove the risk that these legacy schemes pose to their business. Our analysis of 2010 reports shows a continuing trend for pension scheme assets to be moved out of equities and into bonds that more closely match the benefit payments due. The average split of assets for December year-end companies in 2009 and 2010 is shown in the charts below. Summary of UK findings December 2009 December 2010 Other 15.9% Other 16.7% Bonds 38.8% Equities 45.3% Bonds 40.8% Equities 42.5% These charts reveal that the average allocation to equities has reduced by almost 3% during However, this is against a background of strong equity returns relative to other asset classes. For example, over the period from 31 December 2009 to 31 December 2010 equities, as measured by the FTSE All Share Index, returned 14.5%, whereas corporate bonds and government bonds returned between 8% and 10%. If no action had been taken to adjust pension scheme portfolios then the actual allocation to equities would have risen by around 1.5%. This means that the pension schemes of FTSE 100 companies are holding around 15 billion less in equities than would have been expected based on their asset allocation at the start of 2010.

26 26 LCP Accounting for Pensions Summary of UK findings Several companies in particular have disclosed significant switches of assets, with Centrica and Standard Life both moving more than 15% of their pension scheme assets out of equities and into bonds. Bucking the trend were Tesco and Scottish & Southern Energy, which both disclosed a 9% increase in the allocation to equities. Whilst changes to the pension scheme s asset allocation can reduce investment risk, this does not remove the other risks associated with defined benefit pensions - in particular the risk that members live longer than expected and their pensions therefore cost more to pay. To remove longevity risk, schemes can enter into a longevity swap or to remove all investment, inflation and longevity risk, they can purchase a bulk annuity policy with an insurance company (a buy-in or buy-out ). Following the collapse of Lehman Brothers at the end of 2008 there was a sharp decline in the buy-out market and this continued over However, British Airways, GlaxoSmithKline, Next and IMI have all disclosed that their pension schemes purchased pension buy-in policies from insurance companies during More recently, it was reported in the Sunday Times that Invensys has been considering proposals from insurance companies for a full buy-out of its pension scheme liabilities. If such a buy-out were to go ahead, with a premium in the region of 5 billion, this would be by far the largest pensions risk transfer to date. Pensioner buy-ins are at their most affordable level since 2008 and we expect to see an increase in the number of transactions during 2011 and In any event, we expect to see an increase in the number of transactions completed during 2011, particularly for pensioners, as pricing is now at its most competitive since 2008 and funding levels have improved. Funding measures for pensioner liabilities Pensioner liabilities index Dec 2007 Lehman Brothers insolvency Jun 2008 Divergence in pricing Dec 2008 Jun 2009 Dec 2009 Buy-in price Funding reserve Company accounting liability Jun 2010 Pricing most favourable since 2008 Dec 2010 Jun 2011 Source: LCP research

27 Bob Scott Partner LCP Companies are increasingly finding innovative ways of plugging pension scheme deficits or providing security to pension scheme trustees. Summary of UK findings

28 28 Content p28 3. Developments in UK pension provision p The decline of final salary schemes p De-risking p Public sector pension provision

29 Bob Scott Partner LCP 30 years ago, before compulsory indexation, companies could expect to provide a decent final salary pension scheme for a contribution of 12% of salaries. Today, the required contribution is closer to 25% and companies have to pay deficit contributions on top. Faced with such increases - and concerned by the risk that the costs could increase further - it is not surprising that companies have acted to reduce the level of future benefits. Developments in UK pension provision

30 30 LCP Accounting for Pensions Developments in UK pension provision 3.1 The decline of final salary schemes The days when large UK companies provided final salary pensions to their employees are behind us. As the baby boomer generation passes into retirement, the number of employees accruing benefits in final salary schemes continues to fall. As discussed in section 2, figures from the NAPF show that the proportion of schemes closed to all future accrual increased, from 7% to 17% over 2010, and this pattern has been repeated amongst FTSE 100 companies. Even those companies that are continuing to provide accrual of further benefits have modified their schemes so that those benefits are less valuable in future. 30 years ago, companies could expect to provide a decent final salary pension scheme for a contribution of 12% of salaries. The main reason for this decline is cost, along with a greater recognition of the fact that sponsoring employers are exposed to the risk that costs could increase further - whether due to financial, demographic or regulatory factors. 30 years ago, companies could expect to provide a decent final salary pension scheme for a contribution of 12% of salaries. Today, the required contribution is closer to 25% and companies have to pay deficit contributions on top. In the chart below, we highlight some of the factors that have led to this increase. Change in cost of accrual Cost of providing 1/60th salary for male aged 45 retiring in 20 years Allowing for post 1997 indexation in payment Allowing for updated mortality assumptions Allowing for updated financial assumptions (% salary) Not only are people living longer but schemes are required to provide more generous benefits. Compulsory indexation of pensions in payment and in deferment, together with a requirement to provide pensions for spouses and civil partners as a right have all added to the cost.

31 LCP Accounting for Pensions Developments in UK pension provision 31 Investment conditions are less favourable too. Partly this reflects the withdrawal of tax relief on UK dividends combined with much lower general interest rates in recent years. However, as pension schemes de risk, the opportunities to earn greater returns are reduced too. Forthcoming legislative changes are likely to mean further erosion of defined benefit provision: The requirement to auto-enrol all employees into a pension scheme not only increases many companies cost bases but it lends further legitimacy to defined contribution arrangements as the norm. We expect to see many companies taking the opportunity to level down their pension provision so that the minimum becomes the standard. Changes to pension taxation from April 2011 have made it tax inefficient for many high earners to continue defined benefit pensions accrual. This tends to reduce the level of support that senior decision makers have for their defined benefit pension schemes. The Government is consulting on changes to the state pension system, which may lead to the abolition of contracting out. This would mean higher National Insurance contributions for employers and employees. Such a change would affect the majority of defined benefit schemes and, rather than adjust the level of benefit provided to compensate, many companies may simply close their schemes. 3.2 De-risking For several years now, we have seen a shift of pension scheme assets out of equities and into bonds that more closely match the benefit payments due to be made. Five years ago the average pension scheme invested 60% of its assets in equities but this has now fallen to only 43%. We would expect this trend to continue as pension schemes mature and companies look to remove further volatility from their balance sheets. 43% Five years ago the average pension scheme invested 60% of its assets in equities but this has now fallen to only 43%. Developments in UK pension provision In the last few years, a number of companies, including Lonmin, RSA and GlaxoSmithKline, have gone further and purchased insurance policies to cover some or all of their future benefit liabilities. As highlighted in section 2.7, the insurance market is now at its most competitive for some years and we would expect to see more transactions during 2011 and into 2012.

32 32 LCP Accounting for Pensions Developments in UK pension provision Other companies who are further away from being able to secure their liabilities in this way have established a journey plan to eventual self sufficiency and/or buy out with an insurance company. Often, such plans will include systematic switches out of equities into bonds and many incorporate switching mechanisms to lock in favourable asset outperformance automatically. 3.3 Public sector pension provision The Government s announcement on the change to CPI inflation for occupational pension schemes was a knock-on effect of an earlier change in the inflation measure applying for public sector pensions. Following the Hutton Report, further changes to public sector pensions are proposed, as follows: an increase in normal retirement age, with future increases linked to the state pension age; and a change from a final salary basis to a CARE scheme; combined with an increase in the level of contributions required from employees. Not surprisingly, employees in the public sector, and their trade unions, have expressed considerable concern over these changes, which, for many, represent a significant reduction in their overall remuneration package.

33 Bob Scott Partner LCP The requirement to auto-enrol all employees into a pension scheme lends further legitimacy to defined contribution arrangements as the norm. We expect to see many companies taking the opportunity to level down their pension provision so that the minimum becomes the standard. Developments in UK pension provision

34 34 Content p34 4. Accounting standards for pensions p Reduced profits for most companies p Removal of corridor will hit some balance sheets p Strengthening of disclosure requirements p Further changes still possible

35 Nick Bunch Partner LCP Using the new accounting standard for pensions, FTSE 100 companies collectively face a 3 billion reduction in profits and, for a few, a 13 billion hit to balance sheets. Accounting standards for pensions

36 36 LCP Accounting for Pensions Accounting standards for pensions In June 2011 the International Accounting Standards Board ( IASB ) published a revised version of the pensions accounting standard IAS19. This is a shorter, simpler standard, with less subjectivity in setting assumptions and more flexibility in providing appropriate disclosures. The new standard will come into force in 2013, although companies are likely to have the option to adopt the new standard earlier. The main changes in relation to defined benefit pension schemes are described below. The new standard does not introduce any changes in relation to the reporting requirements for defined contribution pension schemes. 4.1 Reduced profits for most companies The most significant of the changes is the removal of the expected return on assets. At present, the return a company expects to earn on its investments is credited to profit. In future, the credit to profit will be calculated using the discount rate, which is based on the yields on AA rated corporate bonds, and is usually lower. Based on disclosures between April 2010 and March 2011 the vast majority of FTSE 100 companies that sponsor defined benefit pension schemes would report lower profits under the new standard. Overall, the total profits for FTSE 100 companies would have been reduced by around 3 billion. This is illustrated in the graph below, which shows the largest estimated decreases and increases, with each bar representing the change for an individual company. Estimated change in profits under new IAS19 standard ( million) million

37 LCP Accounting for Pensions Accounting standards for pensions 37 The companies that face the biggest change in profits under the new standard are shown in the tables below. Largest estimated decrease in profits under new standard Company Year ending Decrease in disclosed profits ( million) Royal Dutch Shell December BT March BP December Largest estimated increase in profits under new standard Company Year ending Increase in disclosed profits ( million) Aviva December Rolls-Royce December Serco December Removal of corridor will hit some balance sheets Under the current international accounting standard companies have two options for dealing with unexpected actuarial gains and losses (which arise mainly due to unanticipated changes in financial conditions affecting asset and liability values): Recognise all gains and losses immediately outside of profit and loss. Recognise only actuarial gains and losses that exceed a specified level (often called a corridor) and spread these over an extended period. The new version of IAS19 removes the second of these options. Accounting standards for pensions

38 38 LCP Accounting for Pensions Accounting standards for pensions This particular change is likely to have a far bigger impact in Europe, where the corridor option is widely used, than in the UK. Of the FTSE 100 companies analysed for our survey, we found that only seven opted to spread actuarial gains and losses rather than recognise them immediately in full. However, even though this is a small group, the total effect will be substantial. If the new standard were applied at companies 2010 year-ends, there would a 13 billion increase in balance sheet liabilities. The effect for individual companies is shown in the table below. Asset/(liability) recognised at 2010 year-end before deferred tax Company Current ( million) New IAS19 ( million) Difference ( million) Old Mutual Man 45 5 (40) BG Group (97) (151) (54) Lloyds Banking Group 479 (480) (959) British Airways 285 (2,120) (2,405) Barclays (87) (2,738) (2,651) Royal Dutch Shell 5,067 (1,655) (6,722) The removal of the corridor will, however, act as an amnesty for companies who have unrecognised actuarial losses. These losses would otherwise have been recognised over future years as a reduction in profits, but the abolition of the corridor will now mean those losses won t hit profits. This may encourage some of the above companies to adopt the new standard in advance of Strengthening of disclosure requirements The headline profit and balance sheet figures, based on the corporate bond based accounting measure, are only a starting point in understanding pension liabilities investors who seek to understand a company s pension exposure need to dig deeper.

39 LCP Accounting for Pensions Accounting standards for pensions 39 The new disclosure requirements will help by providing the answers to a number of key questions: Examples of the new disclosure requirements What would be the effect of using alternative assumptions? When will cash be paid out of the scheme? How much cash will be paid in to the scheme? Comment Requirement to give a sensitivity analysis on assumptions; at present some, but not all companies already give this. A new requirement to disclose the average time until pensions are paid. Some companies, such as BP and Invensys, already provide information about these cashflows. A description of funding arrangements and contributions for the next year. What are the risks? Where are the assets invested? A general requirement to explain the characteristics of pension schemes and the risks associated with them, and specific requirements to disclose concentrations of risks and unusual risks to the company. New disclosure requirements will take into account all of the significant asset classes and liability matching strategies. This will be more useful than the existing requirements, which focus on the basic asset classes of equities, bonds and property. Accounting standards for pensions As we pointed out last year, for many companies the description of material pension scheme risks has in the past been extremely brief and our analysis has shown that this continues to be the case for disclosures in For example, in its 2010 accounts, Marks & Spencer makes no real mention of pension risk despite disclosing pension liabilities of 90% of its market capitalisation.

40 40 LCP Accounting for Pensions Accounting standards for pensions It appears that companies will need to beef up their pensions disclosures when the new standard comes into force. From our analysis, it appears that companies will need to beef up their pensions disclosures when the new standard comes into force. For example, around half of the companies in our survey did not show sensitivities for both the discount rate and mortality assumption used in their 2010 accounts. This is despite a number of these companies having pension schemes that are very material in the context of their business. 4.4 Further changes still possible The new standard will not necessarily be the end of the line for changes in the way in which companies account for their pension obligations. The IASB will soon be starting its next project to re-examine pensions accounting, which will be a more comprehensive, root and branch review. It is possible that in a few years time, we could see proposals for radically different pensions accounting potentially in line with Solvency II type requirements, which will shortly apply for insurance company reserving. If companies were required to value liabilities on such a minimum-risk basis, the increase in the value of pension liabilities disclosed on FTSE 100 companies balance sheets could run to 80 billion.

41 Nick Bunch Partner LCP The removal of the corridor will act as an amnesty for companies who have unrecognised actuarial losses. This change will mean that these losses will now not hit profits. Accounting standards for pensions

42 42 Content p42 5. LCP s analysis of FTSE 100 IAS19 disclosures p Introduction p Analysis of results p Key assumptions

43 Nick Bunch Partner LCP This year s analysis has revealed a small number of companies in the healthcare and financial sectors reducing their expectations of how long pension scheme members will live, along with some significant increases in life expectancy at the other end of the spectrum. Life expectancy assumptions reported in 2010 split by sector Males aged 65 on accounting date Age at death Companies in each sector at 31 December LCP s analysis of FTSE 100 IAS19 disclosures Financials Healthcare Consumer Services Telecommunications Oil & Gas Utilities Basic Materials Industrials Consumer Goods Technology

44 44 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures 5.1 Introduction We have analysed 83 FTSE 100 companies reporting in companies were excluded as they did not sponsor a material defined benefit pension scheme. A full listing can be found in appendix 1. We have concentrated on the financial position of the defined benefit schemes in which the companies employees and former employees participate. Some companies offer post-retirement healthcare, which we have excluded from our analysis, where possible. Overseas pension arrangements have been included, except where otherwise indicated. We have analysed these arrangements in more detail in section 6. The disclosures The average pensions note runs to nearly five pages, with most companies also having several paragraphs of pension commentary in the main body of their reports. The longest disclosure was by Prudential, which dedicated 14 pages of its 2010 report to pensions. For many FTSE 100 companies, pensions are financially significant and the volume of information disclosed in the accounts reflects this. However, for those companies whose pension arrangements are not so material, even the minimum disclosure requirements under IAS19 can be quite onerous. 5.2 Analysis of results Funding levels IAS19 takes a snapshot of the accounting surplus or deficit at the company s year-end and, if the company has not chosen to spread gains and losses via the corridor option, this is generally the number that appears on the balance sheet. We have set out a full list of the disclosed accounting surpluses and deficits of the FTSE 100 companies in appendix 1. The number of companies reporting that pension scheme assets were at least equal to accounting liabilities in their 2010 accounts was higher than in their 2009 accounts. Eleven companies out of the 83 FTSE 100 companies disclosed assets equal to or in excess of accounting liabilities, compared to five last year.

45 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures 45 This general improvement was largely due to recovering investment markets and a continued high level of contributions paid by companies into their pension schemes. Old Mutual disclosed the highest 2010 funding level 114% as at 31 December More than half of companies reported being less than 90% funded on an accounting basis at their 2010 year-end. This shows an overall improvement compared with 2009 accounting year end positions when nearly two thirds of companies had a funding level of less than 90%. Changes over 2010 The chart below shows how worldwide funding levels have changed over the year for the 47 FTSE 100 companies in our report which have December 2010 year-ends. Ratio of assets to IAS19 liabilities at end December (%) under to to to to or over LCP s analysis of FTSE 100 IAS19 disclosures Number of companies The average reported IAS19 funding level for companies with December year-ends increased by 5% from 85% in 2009 to 90% in % The average reported IAS19 funding level for companies with December year-ends was 90%.

46 46 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures We have shown a similar chart for those companies with March year ends below again, the overall trend is an improvement in funding levels between March 2010 and March Ratio of assets to IAS19 liabilities at end March (%) Number of companies March 2009 March 2010 March under to to to or over The average reported IAS19 funding level for these companies was 95% at March 2011 compared with 87% in both 2009 and Sources of deficits and surpluses For the 47 companies with December year-ends, worldwide deficits decreased by 15 billion over Investment returns ( 30 billion) and aggregate contributions in excess of benefits accrued over the year ( 8 billion) were partially offset by increased IAS19 values placed on the projected benefits ( 7 billion) and interest charges ( 16 billion). The overall effect was a net reduction in deficit of 15 billion. IAS19 sources of deficits and surpluses for companies with December year-ends ( billion) Changes in liabilities Changes in assets Interest charged Benefits earned Investment returns and exchange rate differences Contributions New assumptions & experience Overall movement in the deficit

47 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures 47 Pension schemes in relation to their sponsoring companies The chart below shows the size of accounting liabilities relative to companies market capitalisations. The average FTSE 100 pension liability was 49% of market capitalisation, compared to 57% in This reduction was largely due to the continued recovery in investment markets over Despite this, pension schemes still pose a very significant risk for certain companies. For example, British Airways accounting liabilities were over six times the size of its market capitalisation, an improvement compared with almost eight times at its accounting date in % The average FTSE 100 pension liability was 49% of market capitalisation, compared with 57% in Accounting liabilities as a proportion of market capitalisation (%) under 5 5 to to to to to to to or over LCP s analysis of FTSE 100 IAS19 disclosures Number of companies Pension scheme deficits averaged 6% of market capitalisation, compared to 7% in 2009.

48 48 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures However, for some companies, the size of the IAS19 pension scheme deficit is comparable to the value of the company itself. For example, BT s accounting deficit was over 80% the size of its market capitalisation at its 2010 accounting year-end. Accounting deficits as a proportion of market capitalisation (%) Number of companies under 5 or in surplus 5 to 9 10 to to to to or over What have companies done to tackle their deficits? Last year, we reported that FTSE 100 companies paid record contributions of 17.5 billion to their defined benefit schemes in This level was almost matched in 2010 with defined benefit contributions of 17 billion paid over the year. Nearly two-thirds of companies paid higher contributions during 2010 than over 2009, although a few paid significantly less. HSBC and Royal Dutch Shell were the only companies paying more than 1 billion into their schemes over their 2010 accounting years (with HSBC paying over 2 billion). The top six companies that paid the highest contributions are shown in appendix 2. The largest increase in contributions paid over 2010 compared to 2009 was for HSBC, which paid 1.5 billion more into its defined benefit scheme this year than last year.

49 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures 49 Most companies pay contributions at a rate greater than the IAS19 value of benefits earned over the year; if IAS19 assumptions were borne out in reality, this excess would reduce any IAS19 deficit. However, four companies paid contributions lower than or only equal to the IAS19 value of the benefits promised over the year which would not have improved their IAS19 funding position. These were Fresnillo, Hammerson, SABMiller and Sage. The chart below shows the excess contributions that companies paid during the year (ie contributions over and above the IAS19 value of the benefits earned during the year) compared to the deficit that would have been disclosed at the end of the year had these contributions not been paid. Proportion of year-end deficits paid off over the year (%) Number of companies Nil or in surplus 1 to 9 10 to to to to to or over The highest proportion of deficit paid off was by Aviva which reduced its 2010 year end deficit by 99% due to the payment of deficit contributions that had been agreed as part of its triennial actuarial valuation as at 31 March LCP s analysis of FTSE 100 IAS19 disclosures

50 50 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures Pension schemes versus shareholders The following chart shows how pension deficits compare to dividends paid. Of the 72 FTSE 100 companies that disclosed a pension deficit in 2010, 30 disclosed a deficit that was greater than or equal to the dividends paid to their shareholders in However, in 29 cases, the 2010 dividend was more than double the deficit at the year-end in Percentage of deficit that could be paid off with one year's declared dividends (%) 30 Number of companies under to to to to to to to or over The chart below shows the company contributions paid over the 2010 and 2009 accounting years as a percentage of dividends distributed over the same accounting years and therefore illustrates the amount of cash paid to shareholders in preference to the pension scheme. In 2010, ten companies paid more contributions into their pension schemes than they distributed in dividends over the 2010 accounting year. This is the same number as in Contributions paid as a proportion of dividends paid (%) Number of companies under to to to to to to to to to or over

51 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures Key assumptions We consider below the various assumptions used to place an IAS19 value on pension benefits. Where a company operates pension schemes in more than one country, we have considered the assumptions used for the UK if separately given. Where a company has disclosed a range of assumptions, we have taken the mid-point. Life expectancy Under the IAS19 standard, companies are required to disclose any material actuarial assumptions. Whilst no specific mention is made of mortality, the majority of companies have disclosed this assumption. 66 of the 83 companies with material defined benefit pension schemes have provided sufficient information in their 2010 accounts for us to derive basic mortality statistics specifically a male life expectancy at age 65 in the UK. The following charts show the range of life expectancies assumed under IAS19 by FTSE 100 companies for males aged 65 on the balance sheet date. Life expectancy assumptions reported in 2010 Males aged 65 on the accounting date 20 Number of companies or less or above Life expectancy (rounded to nearest age) Companies continue in general to assume increasing life expectancy for members of their pension schemes. The average assumption was that male members in the UK who retire at age 65 on the accounting date would live to 87.1 years up from 86.8 years in their 2009 accounts The average assumption was that male members in the UK who retire at age 65 on the accounting date would live to 87.1 years. LCP s analysis of FTSE 100 IAS19 disclosures

52 52 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures However, the rate of increase appears to be slowing even reversing in some cases. 48 companies have disclosed that they moved to more conservative longevity assumptions in 2010, adding 0.5 years on average to assumed life expectancy. However, three companies chose to weaken their life expectancy assumption for current pensioners, the greatest change being made by Man who reduced their assumed life expectancy by 1.4 years following an investigation into the current rates of mortality of their scheme members. 3i has adopted the strongest mortality assumptions, assuming that male pensioners currently aged 65 will live to Research has shown that two of the main factors influencing life expectancies are socio-economic group and income. In this respect it is interesting to analyse the FTSE 100 companies assumed life expectancies by the sector in which the company operates. 1 The sector is the Industry Classification Benchmark as published by FTSE. In the chart below the horizontal bars show the average life expectancy for a male aged 65 in the UK for each sector. The vertical lines show the extent of the variation within each sector, which clearly increases the greater the number of companies within the sector 1. Life expectancy assumptions reported in 2010 split by sector Males aged 65 on accounting date Age at death Companies in each sector at 31 December Financials Healthcare Consumer Services Telecommunications Oil & Gas Utilities Basic Materials Industrials Consumer Goods Technology

53 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures 53 This chart shows that the highest average assumed life expectancies are found in the financials and healthcare sectors, as last year. The lowest average assumed life expectancies are found in the technology and consumer goods sectors. Future improvements in mortality As well as setting assumptions to estimate how long current pensioners will live on average, companies must also decide how quickly life expectancies for future pensioners will increase as a result of improvements in mortality. Allowing for future improvements can result in a significant increase in pension scheme liabilities, and as a result, deficits. 59 companies disclosed enough information in their accounts to analyse how their allowance for future improvements in mortality has changed over their accounting year. The chart below shows the allowance that these companies have made for increases to longevity over a period of 20 years. Additional life expectancy improvements reported in 2010 Improvements for male members aged 65 now versus aged 65 in Number of companies under 0.5 years 0.5 to 0.99 years 1 to 1.49 years 1.5 to 1.99 years 2 to 2.49 years 2.5 to 2.99 years Increase in life expectancy over next 20 years 3 to 3.49 years 3.5 years or over In their 2010 accounts, FTSE 100 companies assumed that members living in the UK will gain an extra 2.1 years of life expectancy over the coming 20 years, compared to 1.9 years in This shows a continuation of the trend for companies to strengthen their assumptions on mortality improvements. British Land Company have strengthened their improvements the most, stating in their 2010 accounts that a male member currently aged 40 will gain an extra three years of life expectancy over the next 20 years compared to one year assumed in their 2009 accounts. 2.1 years In their 2010 accounts, FTSE 100 companies assumed that members living in the UK will gain an extra 2.1 years of life expectancy over the coming 20 years. LCP s analysis of FTSE 100 IAS19 disclosures FTSE 100 companies increased their average assumption for the life expectancy of a 65 year old in 2030 by 0.8 years, from 88.4 years in 2009 to 89.2 years in 2010.

54 54 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures Discount rates The discount rate is used to calculate a present value of the projected pension benefits. Under IAS19 the discount rate should be based on high quality corporate bonds and the duration of the corporate bonds should be consistent with the estimated duration of the pension obligations. The yields on high quality corporate bonds, and hence the discount rates, will fluctuate from day to day in line with market conditions. We have analysed companies reporting with March 2011 year-ends in addition to December 2010 year-ends. Discount rates used in December 2009, December 2010 and March 2011 (% pa) Proportion of companies 80% 60% 40% 20% December 2009 December 2010 March % under to to to or over The average discount rate fell over the year to December 2010, from 5.7% pa in December 2009 to 5.4% pa in December The average discount rate used by FTSE 100 companies with a March 2011 year-end was 5.5% pa. The spread of discount rates used by FTSE 100 companies has reduced considerably with 80% of companies with a December 2010 year-end adopting a discount rate assumption in the range of 5.4% pa to 5.5% pa. The typical FTSE 100 company has pension liabilities that are linked to price inflation. It is therefore the discount rate net of assumed future price inflation which is the key assumption.

55 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures 55 The chart below shows the difference between the discount rate and the assumption for retail price inflation (the net discount rate) for companies reporting as at 31 December 2009, 31 December 2010 and 31 March The net discount rate has reduced slightly since December 2009, with the fall in nominal corporate bond yields offset to some extent by lower expectations of future inflation. This has had the effect of increasing companies reported pension liabilities. Discount rates in excess of RPI inflation used in December 2009, December 2010 and March 2011 (% pa) Proportion of companies 80% 60% 40% December 2009 December 2010 March % 0% under to to to to or over Inflation assumptions The following chart shows the average long term inflation assumption as measured by the Retail Prices Index ( RPI ), where it could be identified in company accounts. This shows that the average RPI assumption adopted decreased from 3.6% pa in December 2009 to 3.5% pa in December 2010 and in March A decrease in the price inflation assumption will lead directly to a lower level of projected benefit payments, and hence a lower value being placed on those benefits, all other things being equal. RPI inflation used in December 2009, December 2010 and March 2011 (% pa) Proportion of companies 80% 60% 40% 20% December 2009 December 2010 March 2011 LCP s analysis of FTSE 100 IAS19 disclosures 0% under to to to or over

56 56 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures For December 2010 year-ends, the highest RPI inflation assumption was 3.7% pa, adopted by five companies. On the other hand RSA and Unilever, who reported at the same date, adopted an assumption of 3.1% pa. In general, there was a much greater divergence in inflation assumptions than in discount rates. The Bank of England publishes statistics for future price inflation rates implied by gilt spot rates. This showed long-term price inflation implied by 20-year gilt spot rates was around 3.8% pa at the end of December 2009, December 2010 and March This suggests that companies may be reducing the market implied future inflation assumption by as much as 0.7% pa, possibly to allow for an inflation risk premium. This represents the theoretical return that investors are willing to forgo when investing in index-linked gilts, in return for the inflation protection that these assets provide. In July 2010, the Government announced its intention to change its approach to the statutory minimum pension increases that private sector pension schemes must provide. In future, minimum pension increases and revaluation of deferred pensions are to be linked to inflation measured using the Consumer Prices Index ( CPI ) rather than the RPI. Historically CPI has generally increased at a lower rate than RPI. Some companies have already allowed for the impact of this change on their scheme s benefits in their accounts. As no significant market in CPI linked securities currently exists, emerging market practice is to derive an assumption for future CPI inflation by deducting a margin from the assumed future level of RPI inflation. This margin reflects the long term average difference expected between CPI and RPI inflation. The chart below shows the range of margins used by companies in their December 2010 and March 2011 year-end accounts, where information was available. Difference in RPI and CPI inflation assumptions used in December 2010 and March 2011 (% pa) 60% 50% December 2010 March 2011 Proportion of companies 40% 30% 20% 10% 0% under or over

57 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures 57 In February 2011 it emerged that a recent change to the way in which the Office for National Statistics monitors clothing prices is expected to lead to a larger long-term difference in future CPI and RPI inflation. The average margin of 0.7% pa applying at March 2011 was higher than the average of 0.6% pa applying at December 2010 and it is possible that this increase is a result of companies reacting to this change. At 31 March 2011, BT adopted a long-term CPI inflation assumption of 2.4% pa, 1% pa below its RPI inflation assumption, the largest margin at that accounting date. In addition it allowed for a short-term margin of 1.5% pa over 2011/12. Overall, this resulted in a 3.5 billion reduction in its accounting liabilities equivalent to nearly 9% of its pension liabilities being wiped out by the change in inflation measure. 0.7% pa For March 2011 disclosures, future CPI inflation was on average, expected to be 0.7% pa lower than RPI inflation. Salary growth assumptions For final salary schemes the assumed rate of salary growth affects the disclosed IAS19 liability and the cost of benefits being earned. A lower assumption for salary growth produces a lower projected pension and hence lower pension liabilities as well as a lower charge to operating income. The average salary increase assumption (in excess of the RPI inflation assumption) has fallen from 0.9% pa in 2009 to 0.8% pa in As the number of active members in final salary pension schemes reduces, the assumption for salary growth is becoming less significant. Salary growth rates used in excess of RPI inflation (% pa) Number of companies under 0 0 to to to to to or over LCP s analysis of FTSE 100 IAS19 disclosures

58 58 LCP Accounting for Pensions LCP s analysis of FTSE 100 IAS19 disclosures Expected return on equities Under IAS19 companies are not required to provide a breakdown of their assumed asset returns on each asset class but can instead simply provide an overall expected return for the pension assets. For those companies where we could determine the equity return assumption, there is a wide range of values, reflecting the subjectivity in setting this assumption. Expected long-term rate of return on equities (% pa) Number of companies under 7 7 to to to or over 2 This figure is calculated by reference to Bank of England 20-year spot yields at the appropriate date. The lowest assumption was 6.5% pa as disclosed by Legal & General and the highest was 8.9% pa by InterContinental Hotels. The average expected rate of return on equities was 3.3% pa higher than the long-term yields available on gilts as at the balance sheet dates 2. This difference represents companies views of the so-called equity risk premium (which is the additional return expected from investing in equities, compared with low risk assets such as gilts, to compensate for the increase in risk). The average equity risk premium is broadly unchanged from the assumptions used in Where disclosed, six companies increased their assumed equity return, 33 reduced it and 18 companies did not alter their assumption from the previous year. With the upcoming changes to IAS19, the expected return on assets assumption will shortly be redundant.

59 Nick Bunch Partner LCP This year we have seen a considerable reduction in the range of discount rates used by companies for their IAS19 disclosures. Discount rates used in December 2009, December 2010 and March 2011 (% pa) 80% 60% 40% 20% 0% under to to to or over LCP s analysis of FTSE 100 IAS19 disclosures Proportion of companies December 2009 December 2010 March 2011

60 60 Content p60 6. Non-UK schemes of the FTSE 100 p Introduction p Key findings p Analysis of disclosures p Deficit and risk reduction measures p Non-UK pension scheme asset allocation p Consistency of assumptions

61 Colin Haines Partner LCP We estimate that, under IAS19, FTSE 100 companies have in excess of 80 billion of overseas pension and other post-retirement liabilities. Many companies have put in place risk reduction measures in other countries similar to those seen in the UK. Non-UK schemes of the FTSE 100

62 62 LCP Accounting for Pensions Non-UK schemes of the FTSE Introduction We have separately analysed the disclosures made by FTSE 100 companies in relation to their non-uk pension and post-retirement healthcare schemes and compared these to their UK disclosures. 6.2 Key findings Overseas pension and other post-retirement liabilities remain significant for many FTSE 100 companies. We estimate that, under IAS19, FTSE 100 companies have in excess of 80 billion of overseas pension and other post-retirement liabilities. As in the UK, a number of FTSE 100 companies have disclosed steps taken during 2010 to control pension risks and reduce pension deficits in their overseas schemes. Many companies provide healthcare benefits to retired former overseas employees. FTSE 100 companies valued such liabilities at 10 billion, of which 9 billion was for US schemes. Falling discount rates and changes to mortality tables have acted to push up IAS19 pension liabilities in many countries. Many companies adopt different assumptions for calculating their IAS19 liabilities overseas from those that they use in the UK. It is not always clear that such different treatment is justifiable. 6.3 Analysis of disclosures Significance of non-uk arrangements 45 FTSE 100 companies provided separate details of non-uk pension liabilities amounting to 47 billion, of which over 18 billion was for US schemes. The average IAS19 funding level in 2010 was 70% (2009: 72%) for their non-uk pension arrangements compared to 93% (2009: 88%) for the UK schemes of the same companies.

63 LCP Accounting for Pensions Non-UK schemes of the FTSE A number of very large multinationals including BHP Billiton, British American Tobacco, National Grid, Royal Dutch Shell and Unilever provide figures only for their global pension liabilities and do not provide any breakdown by country or region. The 2010 pension liabilities for these companies amounted to 90 billion, with the non-uk part likely to be a significant proportion of the total liability. The chart below shows the 15 companies with the largest disclosed non-uk pension liabilities relative to market capitalisation. Despite a significant increase in market capitalisation over 2010, Invensys still has non-uk liabilities (mainly in respect of its arrangements in the US) which exceeded 50% of its market capitalisation. Non-UK schemes of the FTSE 100 Disclosed non-uk pension liabilities as proportion of market capitalisation (%) Invensys Rexam BAE Systems GKN British Airways Aviva Smiths TUI Travel BP Rolls-Royce RSA Diageo IMI GlaxoSmithKline Wolseley

64 64 LCP Accounting for Pensions Non-UK schemes of the FTSE 100 The chart below shows the 15 companies with the highest non-uk pension liabilities as a proportion of the total pension liabilities. Anglo American, BP, International Power, Rexam, Smith & Nephew and WPP have over 40% of their total pension liabilities in overseas pension schemes. Disclosed non-uk pension liabilities as proportion of total pension liabilities (%) WPP Rexam Smith & Nephew BP Anglo American International Power Standard Chartered AstraZeneca Diageo GlaxoSmithKline HSBC Intertek InterContinental Hotels Compass Invensys A number of FTSE 100 companies, including SABMiller and Xstrata, have most, if not all, of their pension liability outside the UK and have been excluded from the chart above.

65 LCP Accounting for Pensions Non-UK schemes of the FTSE Deficit and risk reduction measures A number of FTSE 100 companies have provided details of measures that they have taken to reduce pension deficits and reduce pension risks in their non-uk schemes, particularly in the US. Examples are given below: Company Reported deficit and risk reduction measures Invensys The main US scheme is no longer final salary following the closure to future accrual and the freezing of benefits for existing members with effect from 1 November Non-UK schemes of the FTSE 100 IMI HSBC Xstrata Unilever Closed six defined benefit arrangements to new entrants and five to future accrual. Reported a one-off accounting gain of $144 million following closure of its North American defined benefit scheme to future accrual. Agreed to pay contributions totalling $392 million to its North America plans. Insured 150 million of liabilities in respect of Swedish pension obligations. 6.5 Non-UK pension scheme asset allocation Typical levels of equity investment by pension schemes vary by location. Compared to the US, the UK and other regions often have a lower proportion of their asset allocations in equities, reflecting the push in recent years of schemes de-risking their investment strategies. Nevertheless, allocations to equities in different countries can differ from company to company. For example, in the US, Invensys and Rexam have equity asset allocations around 20%, whereas BP has over 75% of its US pension scheme assets invested in equities.

66 66 LCP Accounting for Pensions Non-UK schemes of the FTSE 100 The chart below shows equity outperformance relative to government bonds over the period from 31 December 2008 to 30 June 2011 in different locations. In the UK, many pension schemes have put in place triggers to capture this outperformance by disinvesting from equities and buying bonds which are a better match for the scheme s pension liabilities. Given the similar and often higher outperformance seen in overseas locations, multinational companies may want to consider adopting similar de-risking approaches for their non-uk schemes. Local equity outperformance relative to government bonds 31 December 2008 to 30 June % 80% 60% UK Europe Sweden Canada US Japan Switzerland 40% 20% 0% -20% Dec 2008 Jun 2009 Dec 2009 Jun 2010 Dec 2010 Jun Consistency of assumptions Discount rates As for the UK, companies use a range of discount rates to value their pension liabilities in other countries. In the chart below, the horizontal bars show the average discount rate for FTSE 100 companies with 31 December year-ends for each location where this can be identified and how they have moved since 2009 and The vertical lines show the extent of the variation within each location in Disclosed discount rates for companies reporting at 31 December (% pa) Discount rate (% pa) Number of companies in each country for UK US Canada Germany Netherlands Ireland Switzerland

67 LCP Accounting for Pensions Non-UK schemes of the FTSE This analysis suggests that companies adopt a wider range of assumptions in North America than in other locations. It also shows that, in all countries, average discount rates fell over the two year period. Over the last year, discount rates across the regions on average fell by around 0.5% pa which will have resulted in accounting liabilities rising by 5%-10%. We would normally expect discount rates to be broadly the same across the Eurozone from year to year. This was the case for 2008 but not for 2009 or 2010, where higher discount rates have been seen for Irish schemes. For example, Aviva uses a discount rate of 5.6% pa for its Irish pension scheme whereas it uses 5.1% pa for its Dutch pension scheme. Non-UK schemes of the FTSE 100 This is consistent with discount rates we have seen used by large Irish listed companies and could be due to different assumption setting methodologies used by companies with schemes in Ireland at the end of 2009 and Life expectancy FTSE 100 companies continue to adopt a wide range of life expectancy assumptions in different countries as can be seen by the chart below. The horizontal bars show the average life expectancy for a male at retirement age at the accounting date for FTSE 100 companies for different regions and how they have moved since 2009 and The vertical lines show the extent of the variation within each location in Disclosed life expectancies for a male at retirement at the accounting date Life expectancy (years) Number of companies in each country for UK US Canada Germany Netherlands Ireland Switzerland

68 68 LCP Accounting for Pensions Non-UK schemes of the FTSE 100 FTSE 100 companies have adopted a wide range of life expectancy assumptions in different countries, in particular in the UK and US. This chart shows that FTSE 100 companies continue to assume that, on average, pensioners in the UK will live for longer than pensioners in most other countries; however, the gap has reduced over 2010 for all except Germany and Switzerland. The gap has dramatically decreased when compared to the Netherlands and reflects new Dutch mortality tables that have been published and are now being used. New tables have recently been introduced in Switzerland and this may result in companies changing their assumptions for their 2011 accounts. The table below sets out the average life expectancy now and in 20 years time (where this has been disclosed) for a male at retirement age at the accounting date for FTSE 100 companies for different regions. Region Number of companies Life expectancy (current) Life expectancy (20 years time) Additional life expectancy (years) UK US Canada Germany Netherlands Ireland Switzerland This shows that FTSE 100 companies currently allow for the greatest level of future improvements in mortality in the UK, Germany and Ireland. The smallest allowance is in respect of their pension schemes in the US - indeed some FTSE 100 companies, including Bunzl, Compass, GKN, National Grid, Pearson and Smiths, appear to be making no explicit allowance for any future improvements in mortality for their US pension schemes.

69 LCP Accounting for Pensions 2011 Appendix 1: FTSE 100 accounting disclosure listing 69 This table shows the key disclosures made by the companies in the FTSE 100 as at 1 January 2011 that reported IAS19 figures in their 2010 accounts. The source of the data is each company s annual report and accounts for the accounting period ending in The market value of assets and surplus/(deficit) figures relate to the worldwide position of each company, not just the UK schemes. Figures shown are before deferred tax and before any balance sheet asset limits have been applied. All figures are rounded to the nearest million pounds. The assumptions for the discount rate and inflation refer to those disclosed for companies main UK schemes where available. ND means no UK specific figures were disclosed Surplus/(deficit) 2009 Surplus/(deficit) Company Yearend Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 m m m % pa % pa % pa m m m % pa % pa % pa 3i Group Mar 587 (6) (6) ND Y 419 (18) (18) ND Y Aggreko Dec 53 (3) (3) Y 43 (6) (6) Y Alliance Trust Jan 23 (5) (5) Y 19 (2) (2) Y AMEC Dec 1, Y 1,324 (4) (4) Y Anglo American Dec 1,748 (69) 40 ND ND ND N 1,693 (151) (58) ND ND ND N Associated British Foods Sep 2,690 (86) (35) Y 2,373 (80) (37) Y AstraZeneca Dec 5,036 (1,607) (1,291) Y 4,514 (2,110) (1,823) Y Aviva 3 Dec 11,416 (3) Y 10,105 (1,707) (1,589) Y BAE Systems 4 Dec 17,337 (3,125) (2,959) Y 15,142 (4,367) (4,242) Y Barclays 5 Dec 18,905 (2,738) (2,638) Y 16,700 (3,786) (3,658) Y BG Group 5 Dec 824 (151) (112) Y 665 (312) (274) Y BHP Billiton Jun 1,021 (142) (83) Y 873 (169) (127) Y BP Dec 21,903 (2,900) Y 19,471 (3,490) (97) Y British Airways 5 Mar 14,756 (2,070) (1,850) ND N 12,205 (601) (432) ND N British American Tobacco Dec 5,114 (398) (224) Y 4,618 (752) (604) Y British Land Company (The) Mar Y Y BT Group Mar 35,429 (7,864) (7,810) Y 29,353 (3,973) (3,921) Y Bunzl Dec 258 (53) (38) ND ND ND N 223 (60) (47) ND ND ND N Capita Group (The) 6 Dec 648 (25) (25) see note 6 Y 579 (32) (32) see note 6 Y Carnival Nov ND Y 162 (24) (24) ND Y Centrica Dec 4,335 (239) (206) Y 3,533 (565) (534) Y Compass Group Sep 1,639 (390) (216) Y 1,525 (336) (176) Y Diageo Jun 5,367 (1,202) (1,008) Y 4,592 (1,373) (1,201) Y Experian Mar 541 (49) (25) ND Y 417 (32) (13) ND Y Fresnillo Dec 21 (4) (0) ND ND ND N 17 (4) (0) ND ND ND N G4S Dec 1,400 (302) (261) ND Y 1,335 (368) (328) ND Y

70 70 LCP Accounting for Pensions 2011 Appendix 1: FTSE 100 accounting disclosure listing 2010 Surplus/(deficit) Company Yearend Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 m m m % pa % pa % pa GKN Dec 2,660 (600) (193) Y GlaxoSmithKline Dec 12,156 (1,223) (877) Y Hammerson Dec 51 (26) (15) ND Y HSBC Holdings Dec 19,188 (1,834) (1,484) Y ICAP Mar 8 (1) (1) ND ND ND N InterContinental Hotels Group Dec 387 (74) (8) Y IMI Dec 1,116 (184) (126) Y Imperial Tobacco Group Sep 2,960 (842) (62) Y Inmarsat Dec 42 (6) (3) ND ND ND N International Power Dec 336 (108) (108) Y Intertek Group Dec 96 (6) (6) 5.40 ND ND Y Invensys Mar 4,919 (522) (402) Y Investec Mar Y Johnson Matthey Mar 1,045 (202) (189) Y Kingfisher Jan 1,518 (198) (198) Y Land Securities Group Mar 142 (7) (7) Y Legal & General Group 3 Dec 1,293 (234) (234) Y Lloyds Banking Group 5 Dec 26,382 (480) (480) Y Man Group 5 Mar Y Marks & Spencer Group Apr 4,949 (351) (350) Y Morrison (Wm) Supermarkets Jan 2,111 (17) (17) Y National Grid Mar 18,186 (1,412) (1,186) ND Y Next Jan 433 (50) (43) Y Old Mutual 5 Dec 1, N Pearson Dec 1,982 (48) (28) ND Y Prudential 3 Dec 5, Y Reckitt Benckiser Group Dec 1,054 (332) (232) Y 2009 Surplus/(deficit) Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 m m m % pa % pa % pa 2,190 (996) (610) Y 10,694 (1,744) (1,432) Y 47 (21) (11) ND Y 15,106 (3,763) (3,442) Y 8 (2) (2) ND ND ND N 342 (66) (8) Y 1,045 (243) (189) Y 2,798 (794) (47) Y 33 (12) (9) ND ND ND N 277 (97) (97) Y 73 (20) (20) ND Y 4,627 (187) (60) Y Y 778 (112) (101) Y 1,363 (74) (74) Y Y 1,193 (281) (281) Y 23,518 (3,555) (3,555) Y 173 (33) (33) Y 3,977 (136) (135) Y 1,758 (49) (49) Y 14,797 (1,203) (1,000) ND Y 326 (69) (64) Y N 1,727 (240) (222) ND Y 5, Y 801 (263) (171) Y

71 LCP Accounting for Pensions 2011 Appendix 1: FTSE 100 accounting disclosure listing Surplus/(deficit) Company Yearend Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 m m m % pa % pa % pa Reed Elsevier Dec 3,507 (170) (24) ND ND ND N Resolution Limited Dec 1, ND 6.70 Y Rexam Dec 2,637 (334) (253) Y Rio Tinto Dec 8,480 (2,095) (1519) ND N Rolls-Royce Group Dec 8, Y Royal Bank of Scotland Group (The) Dec 22,816 (2,183) (2,022) Y Royal Dutch Shell 5 Dec 40,488 (1,655) 452 ND ND ND N RSA Insurance Group Dec 5,264 (155) (85) Y SABMiller Mar 226 (109) 3 ND ND ND N Sage Group (The) Sep 15 (11) (11) ND ND ND N Sainsbury (J) Mar 4,237 (421) (412) Y Schroders Dec Y Scottish & Southern Energy Mar 2,298 (464) (464) Y Serco Group 7 Dec 1,533 (307) (258) ND ND ND N Severn Trent Mar 1,393 (355) (347) Y Smith & Nephew Dec 616 (145) (131) Y Smiths Group Jul 3,043 (281) (215) Y Standard Chartered Dec 1,377 (177) (88) Y Standard Life Dec 2, ND Y Tesco Feb 4,696 (1,840) (1,786) ND ND ND Y TUI Travel Sep 1,215 (494) (358) Y Unilever Dec 13,764 (1,219) (123) Y United Utilities Group Mar 1,911 (271) (264) ND Y Vedanta Resources Mar 22 (24) (24) ND ND ND N Vodafone Group Mar 1,487 (203) (138) ND ND ND Y Weir Group (The) Dec 595 (65) (57) Y Whitbread Mar 1,281 (434) (434) Y 2009 Surplus/(deficit) Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 m m m % pa % pa % pa 3,067 (235) (105) ND ND ND N 1, ND 7.30 Y 2,480 (266) (193) Y 7,706 (2,362) (1,697) N 7,402 (135) N 27,925 (2,905) (2,707) Y 36,802 (2,039) (128) ND ND ND N 4,810 (330) (273) Y 208 (84) 6 ND ND ND N 20 (12) (12) ND ND ND N 3,310 (309) (300) Y 573 (41) (41) Y 1,787 (143) (143) Y 1,357 (388) (339) ND ND ND N 1,075 (233) (227) Y 531 (182) (168) Y 2,775 (312) (253) Y 1,245 (296) (213) Y 1,836 (88) (42) ND Y 3,420 (1,494) (1,455) ND ND ND Y 1,079 (501) (386) Y 12,793 (1,723) (652) Y 1,484 (213) (207) ND Y 16 (20) (20) ND ND ND N 1,100 (232) (96) ND ND ND Y 552 (71) (64) Y 1,107 (233) (233) Y

72 72 LCP Accounting for Pensions 2011 Appendix 1: FTSE 100 accounting disclosure listing 2010 Surplus/(deficit) 2009 Surplus/(deficit) Company Yearend Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 Market value of assets Total Funded schemes Discount rate Inflation 1 Expected return on equities Disclosed mortality? 2 m m m % pa % pa % pa m m m % pa % pa % pa Wolseley Jul 724 (432) (365) Y 640 (341) (280) Y WPP Dec 631 (240) (106) Y 588 (248) (116) Y Xstrata Dec 1,407 (400) (395) ND ND ND N 1,326 (254) (250) ND ND ND N Notes: 1 We have listed RPI as the measure of inflation and excluded CPI where it could be identified in the accounts. 2 This column indicates companies who disclosed sufficient information to calculate their assumption for life expectancy for a male pensioner in the UK. 3 Aviva, Legal & General and Prudential split their pension scheme surplus/(deficit) between shareholder and with-profit funds and hold group insurance policies in respect of some of their obligations. We have included the IAS19 value of these policies in the figures stated above, and they are as follows: Aviva: 1,445m (2009: 1,351m), Legal & General: 514m (2009: 465m) and Prudential: 254m (2009: 223m). 4 The figures for BAE Systems exclude 696m of its 2010 IAS19 deficit ( 979m in 2009) which is allocated to equity accounted investments and other participating employers and include 261m ( 227m in 2009) of assets held in trust. 5 All of the companies above accounted using immediate recognition of gains and losses (through Other Comprehensive Income ), with the exception of Barclays, BG Group, British Airways, Lloyds Banking Group, Man Group, Old Mutual and Royal Dutch Shell who opted to spread gains and losses under IAS19. 6 Capita Group disclosed an assumption for expected return on equities/hedge funds/absolute returns of 5.5% pa to 7.6% pa as at its 2010 accounting date (2009: 5.8% pa to 7.9% pa). 7 The figures quoted for Serco Group relate to the total across all its defined benefit pension schemes. Some of the surplus/(deficit) relates to contracts under which the pension costs are due to be reimbursed. The 2010 figures are as at the end of the accounting periods ending in The 2009 figures are as at the start of the accounting period. All figures shown above were taken from IAS19 disclosures. The market value of assets and surplus/(deficit) figures before tax and application of any balance sheet asset limits relate to the worldwide position of each company, not just the UK disclosure. Traditionally, some companies with overseas pension plans do not fund them via an external scheme, instead backing the pension plan with company assets, which may result in a larger deficit being disclosed. Where disclosed, the surplus/(deficit) attributable to funded schemes is also shown above. The figures have been converted to Sterling where a company has reported figures in its accounts in a different currency. The discount rate and inflation assumption refer to those disclosed for companies main UK scheme(s). Where a company has disclosed a range of assumptions, we have taken the mid-point. Where a company operates pension schemes in more than one country, we have considered the assumptions used for the UK if separately given. ND means no UK specific figures were disclosed. We have excluded from our survey the following 17 companies who had no evidence of significant defined benefit provision: ARM Holdings, Admiral Group, African Barrick Gold, Antofagasta, Autonomy Corporation, British Sky Broadcasting, Burberry Group, Cairn Energy, Capital Shopping Centres Group, Essar Energy, Eurasian Natural Resources, Kazakhmys, Lonmin, Petrofac, Rangold Resources, Shire and Tullow Oil. The following six companies have entered the FTSE 100 index since 1 January 2011 and hence are not included in our survey: Glencore International, Hargreaves Lansdown, ITV, International Airlines Group, Tate & Lyle and Wood Group. The following six companies have exited the FTSE 100 index since 1 January 2011: African Barrick Gold, Alliance Trust, British Airways, Bunzl, Invensys and TUI Travel.

73 LCP Accounting for Pensions 2011 Appendix 2: FTSE 100 accounting risk measures 73 These tables show the key results of analysis of the disclosures made by the companies in the FTSE 100 as at 31 December 2010 that were reported in their 2010 accounts. The figures relate to the worldwide position of each company (not just the UK disclosure) but exclude healthcare and defined contribution pension arrangements, where possible. The source of the data is each company s annual report and accounts for the accounting period ending in The surplus/(deficit) figures are before allowing for deferred tax and before any balance sheet asset limit has been applied. Traditionally, some companies with overseas pension schemes do not fund them via an external scheme, instead backing the pension scheme with company assets, which may result in a larger deficit being disclosed. The source of market capitalisation figures is the FTSE All-Share Index Series Weightings reports as at the companies year-ends (where available). Largest liabilities Company 2010 Liabilities m 2009 Liabilities m BT Group 43,293 33,326 Royal Dutch Shell 42,143 38,841 Lloyds Banking Group 26,862 27,073 Royal Bank Of Scotland Group 24,999 30,830 BP 24,803 22,961 Barclays 21,643 20,486 Largest deficits Company 2010 Deficit m 2009 Deficit m BT Group 7,864 3,973 BAE Systems 1 3,125 4,367 BP 2,900 3,490 Barclays 2,738 3,786 Royal Bank Of Scotland Group 2,183 2,905 Rio Tinto 2,095 2,362 1 The deficit figures for BAE Systems exclude 696m of its 2010 deficit ( 979m in 2009) allocated to equity accounted investments and other participating employers and include 261m ( 227m in 2009) of assets held in trust. All figures shown here have been calculated using unrounded numbers. Therefore, some metrics shown may differ to those calculated using the rounded figures. Largest liabilities compared to market capitalisation Company Liabilities m Market cap m 2010 Liabilities/ Market cap % 2009 Liabilities/ Market cap % British Airways 16,826 2, BT Group 43,293 9, Invensys 5,441 2, BAE Systems 2 21,158 11, RSA 5,419 4, National Grid 19,598 15, The figures for BAE Systems include all liabilities of the multi-employer plans that the Group participates in.

74 74 LCP Accounting for Pensions 2011 Appendix 2: FTSE 100 accounting risk measures Largest deficit compared to market capitalisation Company Deficit m Market cap m 2010 Deficit/ Market cap % 2009 Deficit/ Market cap % BT Group 7,864 9, British Airways 2,070 2, BAE Systems 1 3,125 11, TUI Travel 494 2, Invensys 522 2, GKN 600 3, Highest funding level Company Assets m Liabilities m 2010 Assets/ Liabilities % 2009 Assets/ Liabilities % Old Mutual 1, Standard Life 2,228 2, Resolution Limited 1,113 1, Schroders Prudential 3 5,913 5, Carnival Prudential splits its pension scheme surplus/(deficit) between shareholder and with-profit funds and holds group insurance policies in respect of some of its obligations. We have included the IAS19 value of these policies in the asset and liability figures stated above, which was 254m for 2010 (2009: 223m) Lowest funding level Company Assets m Liabilities m 2010 Assets/ Liabilities % 2009 Assets/ Liabilities % Vedanta Resources Sage Group Wolseley 724 1, Hammerson SABMiller TUI Travel 1,215 1,

75 LCP Accounting for Pensions 2011 Appendix 2: FTSE 100 accounting risk measures 75 Largest service cost 4 Company 2010 Service cost m 2009 Service cost m Royal Dutch Shell Royal Bank Of Scotland Group BP Lloyds Banking Group Tesco HSBC Holdings The service cost (representing the value of benefits earned over the accounting period) includes the value of any past service benefits awarded to members during the year. 5 Royal Bank of Scotland Group s service cost includes 55m of expenses (2009: 22m). Largest employer contributions Company 2010 Contributions m 2009 Contributions m HSBC Holdings 2, Royal Dutch Shell 1,341 3,340 BT Group BAE Systems BP Royal Bank Of Scotland Group 832 1,153 Largest increase in employer contributions m 2010 Employer 2009 Employer Increase in employer Company contributions m contributions m contributions m HSBC Holdings 2, ,529 BT Group GKN Aviva Rio Tinto BP

76 76 LCP Accounting for Pensions 2011 Appendix 2: FTSE 100 accounting risk measures Highest employer contributions compared to dividends paid 6 Company Contributions m Dividends m 2010 Contributions /Dividends % 2009 Contributions /Dividends % GKN ,617 5,100 Lloyds Banking Group ,379 1,603 3i Group BT Group Invensys ,400 Serco Group Wolseley did not pay a dividend in 2010 or 2009 but contributed 42m to its pension scheme in 2010 (2009: 47m). British Airways did not pay a dividend during its 2010 accounting year but contributed 364m to its pension scheme. Largest employer contributions compared to service cost Company Contributions m Service cost m 2010 Contributions less service cost m 2009 Contributions less service cost m HSBC Holdings 2, , BT Group Royal Dutch Shell 1, ,779 Barclays GlaxoSmithKline BAE Systems Highest equity allocation Company 2010 Equity allocation % 2009 Equity allocation % Inmarsat BG Group BP International Power Wolseley Bunzl British Land Company 62 58

77 LCP Accounting for Pensions 2011 Appendix 2: FTSE 100 accounting risk measures 77 Lowest equity allocation Company 2010 Equity allocation % 2009 Equity allocation % IMI 7 53 Prudential Invensys 12 9 Sage Group Resolution Limited Rolls-Royce Group G4S Largest % increase in funding level 2010 Funding level 2009 Funding level Increase in Funding level Accounting date Company % % % Man Group Mar Carnival Nov BG Group Dec Intertek Group Dec Standard Life Dec Aviva Dec 7 Aviva splits its pension scheme surplus/(deficit) between shareholder and with-profit funds and holds group insurance policies in respect of some of its obligations. We have included the IAS19 value of these policies in the asset and liability figures, which was 1,605m for 2010 (2009: 1,508m) Largest % decrease in funding level 2010 Funding level 2009 Funding level Decrease in Funding level Accounting date Company % % % Alliance Trust Jan Scottish & Southern Energy Mar Investec Mar Whitbread Mar British Airways Mar Land Securities Group Mar

78 78 LCP Accounting for Pensions 2011 Appendix 2: FTSE 100 accounting risk measures Highest gain on assets 8 Company 2010 Gain % 2009 Gain % Standard Life HSBC Holdings BAE Systems Schroders 14 6 Intertek Group BP Figures calculated as a percentage of assets at the start of the accounting year (December year-ends only). Notes

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80 LCP Accounting for Pensions 2011 Bob Scott Partner +44 (0) Nick Bunch Partner +44 (0) LCP is a firm of financial, actuarial and business consultants, specialising in the areas of pensions, investment, insurance and business analytics. Lane Clark & Peacock LLP London, UK Tel: +44 (0) enquiries@lcp.uk.com Lane Clark & Peacock LLP Winchester, UK Tel: +44 (0) enquiries@lcp.uk.com Lane Clark & Peacock Belgium CVBA Brussels, Belgium Tel: +32 (0) info@lcpbe.com Lane Clark & Peacock Ireland Limited Dublin, Ireland Tel: +353 (0) enquiries@lcpireland.com Lane Clark & Peacock Netherlands B.V. Utrecht, Netherlands Tel: +31 (0) info@lcpnl.com LCP Libera AG LCP Libera AG LCP Asalis AG Lane Clark & Peacock UAE Zürich, Switzerland Basel, Switzerland Zürich, Switzerland Abu Dhabi, UAE Tel: +41 (0) Tel: +41 (0) Tel: +41 (0) Tel: +971 (0) info@libera.ch info@libera.ch info@asalis.ch info@lcpgcc.com All rights to this document are reserved to Lane Clark & Peacock LLP ( LCP ). This document may be reproduced in whole or in part, provided prominent acknowledgement of the source is given. LCP is part of the Alexander Forbes Group, a leading independent provider of financial and risk services. Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC LCP is a registered trademark in the UK (Regd. TM No ) and in the EU (Regd. TM No ). All partners are members of Lane Clark & Peacock LLP. A list of members names is available for inspection at 30 Old Burlington Street W1S 3NN, the firm s principal place of business and registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members (as defined under the Act) of the Institute and Faculty of Actuaries, a Designated Professional Body. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. Lane Clark & Peacock UAE operates under legal name Lane Clark & Peacock Belgium Abu Dhabi, Foreign Branch of Belgium. Lane Clark & Peacock LLP. UK c0711/0711