Pension costs and liabilities for UK-regulated utilities

Abstract

AbstractThis paper argues that a substantial portion of the risks associated with the defined benefit (DB) pension schemes operated by regulated utilities in the UK will, in practice, fall on customers via the tariffs that they pay for regulated goods and services. It examines the assumptions made by regulated companies in their FRS 17 valuations. These assumptions generate parameters that systematically understate both the present value of pension liabilities and current service costs. These are re-estimated using the risk-free real rate of discount and compatible assumptions. On this basis, the total pension deficit for the sample increased from £12.7 billion to £56.3 billion in 2009, equivalent to about 110% of regulated revenues. Further, the cost of current service for 2008–09 was 20% higher than total contributions in the year, despite large top-up contributions. If contributions were increased to cover current service costs and to eliminate pension deficits over a period of 10 years, the additional contributions would amount to 235% of actual contributions or 13% of regulated revenues implying a significant increase in regulated charges. Companies in the communications and transport sectors face the largest adjustments in addressing the problems of underfunded pension schemes.