Home > News > 2000 > April 2000 > The Minimum Funding Requirement and Vodafone
The Minimum Funding Requirement and Vodafone
For further information, please contact Nick Salter at the Amersham office.
There has been some press comment on this subject recently.
Background to the issue
As a direct result of Vodafone buying Mannesmann the Minimum Funding Requirement (MFR) funding level of UK final salary pension schemes has fallen by as much as 4 per cent. Prior to the merger, Mannesmann was not listed on the UK equity market but now the company is included (under the guise of Vodafone). This significant increase in the UK equity market capitalisation did not have a corresponding increase in dividends. The average dividend yield of all UK companies was 2.30 per cent, but Vodafone was only 0.4 per cent - after the merger the average dividend yield fell to 2.20 per cent as a result.
This is important because the MFR, which applies to all final salary pension schemes, has a prescribed calculation method based on the UK stock market dividend yield.
The reason for the fall
In fact, the MFR liabilities are calculated with reference to a notional portfolio of assets (a mix of equities and bonds) that is specific to each pension scheme. When the dividend yield fell from 2.30 per cent to 2.20 per cent the "equity part" of the MFR liabilities (broadly liabilities in respect of active and deferred members more than a few years younger than retirement age) increased by 4.5 per cent (the percentage difference between 2.2 per cent and 2.3 per cent) but the market value of pension schemes' equities did not increase correspondingly to compensate.
The fall in MFR funding levels does not imply poor investment performance. The problem does not rest with the scheme's actual investments but with the fact that the MFR test is flawed because it relies too heavily on the equity dividend yield.
What are the consequences?
The fall in the MFR funding level is real but there has not been a change in the long term ongoing solvency of a pension scheme. However for pension schemes which fall in to an MFR funding deficit there is a legal requirement for sponsoring employers to plan additional contributions to make up the deficit. Nevertheless we feel that the following two points are important:-
- Benefits (and actual investment performance) determine final salary pension scheme costs, not MFR rules. The true underlying costs have not therefore changed.
- The Actuarial Profession and the DSS recognise that the current MFR test is not working. A review, which has been underway for the last year, will result in a new MFR test sometime in the next couple of years. The Profession is reporting to the DSS in April and will be recommending substantial changes.
Unfortunately, whilst we await change, we cannot expect any immediate relaxation in current MFR rules and overriding legislative requirements must be complied with. There may therefore be some impact on the timing of pension contributions for some schemes in the short term (ie some payments may have to be made sooner rather than later). There will also be an impact on minimum transfer values (which will have become inflated by 4.5 per cent in broad terms).
What about technology stocks?
This effect on the MFR is not restricted to the Vodafone/Mannesmann merger; the same effect can be seen as a trend over a longer period of time (and may continue) as technology stocks become a more significant part of the stock market. The reason is that, like Vodafone, technology stocks tend to make low (or no) dividend payments to shareholders compared to more traditional stocks.
This is quite a technical matter but we hope this article has helped to put it in context.
For further information, please contact Nick Salter at the Amersham office.
Nick Salter, April 2000.