Defined benefit schemes
The group participates in two major funded defined benefit pension schemes in the United Kingdom – the United Utilities Pension Scheme (UUPS) and the United Utilities PLC group of the Electricity Supply Pension Scheme (ESPS), both of which are closed to new employees. The assets of these schemes are held in trust funds independent of the group's finances.
The trustees are composed of representatives of both the employer and employees. The trustees are required by law to act in the interests of all relevant beneficiaries and are responsible for the investment policy with regard to the assets plus the day-to-day administration of the benefits.
In the year ended 31 March 2019, the majority of active members in the defined benefit sections of the UUPS transitioned to a hybrid section comprising both defined benefit and defined contribution elements. Pension benefits relating to pensionable service before 1 April 2018 were unaffected by the changes. This transition is a consequence of an increase in future service costs and is intended to reduce the overall costs and risk to the group while balancing the interests of employees by maintaining an element of defined benefit pension provision.
The group also operates a series of historic unfunded, unregistered retirement benefit schemes. The costs of these schemes are included in the total pension cost, on a basis consistent with IAS 19 'Employee Benefits' and the assumptions set out below.
Information about the pension arrangements for executive directors is contained in the directors' remuneration report.
Under the schemes, employees are entitled to annual pensions on retirement. Benefits are also payable on death and following other events such as withdrawing from active service. No other post-retirement benefits are provided to these employees.
The defined benefit obligation includes benefits for current employees, former employees and current pensioners as analysed in the table below:
|Total value of current employees benefits||754.3||913.8|
|Deferred members benefits||651.4||748.6|
|Pensioner members benefits||2,019.5||1,836.3|
|Total defined benefit obligation||3,425.2||3,498.7|
The duration of the combined schemes is around 18 years. The schemes' duration is an indicator of the weighted-average time until benefit payments are settled, taking account of the split of the defined benefit obligation between current employees, deferred members and the current pensioners of the schemes.
The latest finalised funding valuations of the schemes were carried out by independent qualified actuaries as at 31 March 2018, earlier than originally planned due to the aforementioned changes to the pension scheme, and determined that the schemes were both in a deficit position on a funding basis. The basis on which scheme liabilities are valued for funding purposes differs from the basis required under IAS 19, with liabilities on a funding basis being subject to assumptions at the valuation date that are not updated between revaluations. Funding deficits vary significantly from company to company, but neither the deficits, the assumptions on which they are based, the associated sensitivities, nor the risk exposures are disclosed by many companies and, therefore, meaningful cross-company comparisons are not possible. Conversely, scheme liabilities are valued on a consistent basis between companies under IAS 19 and are subject to assumptions and sensitivities that are required to be disclosed. Consequently, the relative economic positions of companies are comparable only on an IAS 19 basis, subject to normalisation of assumptions used between companies.
A retirement benefit surplus was recognised as an asset at both 31 March 2019 and 31 March 2018 as, under both the UUPS and ESPS scheme rules, the group has an unconditional right to a refund of the surplus assuming the full settlement of the plans' liabilities in a single event, such as a scheme wind-up.
Under UK legislation there is a requirement that pension schemes are funded prudently, and that funding plans are agreed by pension scheme trustees. The group had plans in place with the schemes' trustees to address the funding deficits by 31 December 2021 for the UUPS and 30 September 2024 for the ESPS, through a series of deficit recovery contributions. This timescale has been accelerated, with accelerated deficit repair contributions of £97.6 million and £5.4 million made to the UUPS and ESPS respectively in April 2019. These payments represent the final acceleration of deficit repair contributions set out in the schedules of contributions agreed with the schemes' trustees as part of the 31 March 2018 valuation process, and reduce the deficit repair contributions payable, due from the company, to nil.
As the 2018 valuation basis was consistent with a long-term target for self-sufficiency, the expectation is that there should be minimal ongoing reliance on the company by the pension schemes.
The group and trustees have agreed long-term strategies for reducing investment risk in each scheme. This includes an asset-liability matching policy which aims to reduce the volatility of the funding level of the pension plan by investing in assets, such as corporate bonds and gilts, supplemented by swap and gilt long-term hedges of interest and inflation rates, which perform in line with the liabilities so as to hedge against changes in interest and inflation rates.
In addition, in the year ended 31 March 2019, the investment and risk management strategy continued to evolve with both UUPS and ESPS now fully hedging inflation exposure through external market swaps and gilts. As a consequence, the Inflation Funding Mechanism (IFM), which previously provided an element of inflation hedging directly with the company, has now ceased to apply and, therefore, no IFM payments were made during the year. Further details of the derivatives used in reducing investment risk are disclosed in the 'Further reporting analysis' section of this appendix.
The group expects to make further contributions of £8.4 million in the year ending 31 March 2020, £7.1 million and £0.9 million in respect of current service contributions to UUPS and ESPS respectively, and £0.4 million in respect of expenses to the ESPS.
The schemes' funding plans are reviewed regularly, and the next funding valuation for UUPS and ESPS is due no later than 31 March 2021.
Impact of scheme risk management on IAS 19 disclosures
Under the prescribed IAS 19 basis, pension scheme liabilities are calculated based on current accrued benefits. Expected cash flows are projected forward allowing for RPI and CPI and the current member mortality assumptions. These projected cash flows are then discounted by a high-quality corporate bond rate, which comprises an underlying interest rate and a credit spread.
The group has de-risked its pension schemes through hedging strategies applied to the underlying interest rate and the forecast RPI and CPI. Due to the IFM ceasing to exist, as mentioned above, both UUPS and ESPS are now fully hedging inflation exposure along with underlying interest rates through external market swaps and gilts, the value of which is included in the schemes' assets.
Consequently, the reported statement of financial position under IAS 19 remains volatile due to changes in credit spread which have not been hedged, primarily due to the difficulties in doing so over long durations, and changes in mortality as management has decided, at the current time, not to hedge this exposure due to its lower volatility in the short term and the relatively high hedging costs.
In contrast, the schemes' specific funding bases, which formed the basis for regular deficit repair contributions, are unlikely to suffer from significant volatility due to credit spread, because a prudent, fixed credit spread assumption is applied.
Pension benefits under the defined benefit element of the new UUPS hybrid section, that became effective for pensionable service from 1 April 2018, are linked to CPI rather than RPI.
In the year ended 31 March 2019, the discount rate decreased by 0.2 per cent (2018: 0.05 per cent increase), which includes a 0.1 per cent decrease in credit spreads and a 0.1 per cent decrease in gilt yields over the year. The IAS 19 remeasurement gain of £73.0 million (2018: £50.2 million) reported in note 18 has largely resulted from the favourable impact of updated membership data due to the 2018 funding valuation, changes in mortality assumptions, and growth asset gains, partially offset by the reduction in credit spreads and gilt yields during the year.
Guaranteed Minimum Pensions (GMP) equalisation
On 26 October 2018, the High Court issued its ruling in a landmark case involving Lloyds Banking Group on GMP. The implication of the ruling is that GMP will be equalised for males and females. The impact of GMP equalisation under the chosen C2 method of calculation is £5.5 million (0.2 per cent of liability) for the UUPS and £1.1 million (0.3 per cent of liability) for the ESPS, resulting in an overall increase in the pension liability of £6.6 million as a result of additional benefits being recognised, with a corresponding amount recorded in past service costs in the income statement. Any future true-up costs will be accounted for in other comprehensive income as a change in management estimate.
Reporting and assumptions
The results of the latest funding valuations at 31 March 2018 have been adjusted for IAS 19 in order to assess the position at 31 March 2019, by taking account of experience over the period, changes in market conditions, and differences in the financial and demographic assumptions. The present value of the defined benefit obligation, and the related current service costs, were measured using the projected unit credit method.
Member data used in arriving at the liability figure included within the overall IAS 19 surplus has been based on the finalised actuarial valuations as at 31 March 2018 for both UUPS and ESPS.
The main financial and demographic assumptions used by the actuary to calculate the defined benefit surplus of UUPS and ESPS are outlined below:
|Pensionable salary growth and pension increases||3.45||3.35|
|Price inflation – RPI||3.45||3.35|
|Price inflation – CPI||2.05||1.95|
The discount rate is consistent with a high-quality corporate bond rate, with 2.40 per cent being equivalent to gilts plus 90 basis points (31 March 2019: 2.60 per cent being equivalent to gilts plus 100 basis points).
At both 31 March 2019 and 31 March 2018, mortality in retirement is assumed to be in line with the Continuous Mortality Investigation's (CMI) S2PA year of birth tables, with a scaling factor of 106 per cent and 109 per cent for male pensioners and non-pensioners respectively and 104 per cent and 105 per cent for female pensioners and non-pensioners respectively (2018: 108 per cent for males and 102 per cent for females), reflecting actual mortality experience. At 31 March 2019, mortality in retirement is based on CMI 2018 (2018: CMI 2016) long-term improvement factors, with a long-term annual rate of improvement of 1.50 per cent (2018: 1.75 per cent). The current life expectancies at age 60 underlying the value of the accrued liabilities for the schemes are:
|Retired member – male||26.4||27.0|
|Non-retired member – male||27.5||28.7|
|Retired member – female||28.6||29.4|
|Non-retired member – female||30.0||31.1|
Sensitivity of the key scheme assumptions
The measurement of the group's defined benefit surplus is sensitive to changes in key assumptions, which are described above. The sensitivity calculations presented below allow for the specified movement in the relevant key assumption, while all other assumptions are held constant. This approach does not take into account the interrelationship between some of these assumptions or any hedging strategies adopted.
- Asset volatility – If the schemes' assets underperform relative to the discount rate used to calculate the schemes' liabilities, this will create a deficit. The schemes hold some growth assets (equities, diversified growth funds and emerging market debt) which, though expected to outperform the discount rate in the long term, create volatility in the short term. The allocation to growth assets is monitored to ensure it remains appropriate given the schemes' long-term objectives.
- Discount rate – An increase/decrease in the discount rate of 0.1 per cent would have resulted in a £73.2 million (2018: £72.7 million) decrease/increase in the schemes' liabilities at 31 March 2019, although as long as credit spreads remain stable this will be largely offset by an increase/decrease in the value of the schemes' bond holdings and other instruments designed to hedge this exposure. The discount rate is based on high-quality corporate bond yields of a similar duration to the schemes' liabilities.
- Price inflation – An increase/decrease in the inflation assumption of 0.1 per cent would have resulted in a £68.4 million (2018: £68.1 million) increase/decrease in the schemes' liabilities at 31 March 2019, as a significant proportion of the schemes' benefit obligations are linked to inflation. However, nearly all of the schemes' liabilities were hedged for RPI in the external market at 31 March 2019, meaning that this sensitivity is likely to be insignificant as a result. As assumptions for pensionable salary growth and pension increases are in line with those for price inflation, sensitivities are also in line.
- Mortality long-term improvement rate – An increase in the mortality long-term improvement rate to 1.75 per cent would have resulted in a £37.5 million decrease in the schemes' liabilities at 31 March 2019.
- Life expectancy – An increase/decrease in life expectancy of one year would have resulted in a £137.1 million (2018: £128.6 million) increase/decrease in the schemes' liabilities at 31 March 2019. The majority of the schemes' obligations are to provide benefits for the life of the member and, as such, the schemes' liabilities are sensitive to these assumptions.
Further reporting analysis
At 31 March, the fair values of the schemes' assets recognised in the statement of financial position were as follows:
|Other non-equity growth assets||7.7||302.5||5.7||219.1|
|Total fair value of schemes' assets||100.0||3,909.1||100.0||3,842.9|
|Present value of defined benefit obligations||(3,425.2)||(3,498.7)|
|Net retirement benefit surplus||483.9||344.2|
The fair values in the table above are all based on quoted prices in an active market, with the exception of £203.8 million (2018: £150.1 million) of assets included in 'Other', which fall within the 'Level 3' fair value categorisation in accordance with IFRS 13 'Fair Value Measurement'.
The assets, in respect of UUPS, included in the table above, have been allocated to each asset class based on the return the assets are expected to achieve as UUPS has entered into a variety of derivative transactions to change the return characteristics of the physical assets held in order to reduce undesirable market and liability risks. As such, the breakdown shown separates the assets of the schemes to illustrate the underlying risk characteristics of the assets held.
The portfolio contains a proportion of assets set aside for collateral purposes linked to the derivative contracts entered into, as described above. The collateral portfolio, comprising cash and eligible securities readily convertible to cash, provides sufficient liquidity to manage the derivative transactions and is expected to achieve a return in excess of LIBOR.
The fair value of derivatives included within pension scheme asset classification are analysed as follows:
|Fair value of derivatives |
|At 31 March 2019|
|Other non-equity growth assets||302.5||–||302.5|
|Total fair value of schemes' assets||3,808.5||100.6||3,909.1|
|At 31 March 2018|
|Other non-equity growth assets||219.1||–||219.1|
|Total fair value of schemes' assets||4,120.9||(278.0)||3,842.9|
The derivative values in the table above represent the net market value of derivatives held within each of these asset categories as follows:
- Derivatives are held within the UUPS equity portfolio to gain economic exposure equivalent to around 4.0 per cent of that scheme's assets, and comprise total return swaps on equity indices with a value of £nil (2018: £4.7 million) and currency forwards with a value of £(4.0) million (2018: £1.9 million).
- Derivatives are used within both the UUPS and ESPS bond portfolio to hedge non-sterling exposure back to sterling:
- The UUPS total value of £(17.1) million comprises interest rate swaps with a value of £(15.0) million (2018: £(3.9) million) and currency forwards with a value of £(2.1) million (2018: £1.1 million); and
- The ESPS total value of £1.9 million (2018: £3.4 million) relates to interest rate swaps.
- Derivatives are used within both the UUPS and ESPS 'other' portfolios to manage liability risks. Both schemes use a range of derivatives to target a high level of interest rate and inflation hedging, comprising £112.7 million (2018: £(285.9) million) in the UUPS and £7.1 million (2018: £0.7 million) in the ESPS. These are further broken down as follows:
- The UUPS net value of £112.7 million (2018: £(285.9) million) comprises asset swaps with a value of £(32.7) million (2018: £(27.3) million), interest rate swaps with a value of £143.6 million (2018: £252.1 million), gilt repurchase agreements with a value of £nil (2018: £(517.2) million) and RPI inflation swaps with a value of £1.8 million (2018: £6.5 million); and
- The ESPS net value of £7.1 million (2018: £0.7 million) represents gilt repurchase agreements with a value of £7.4 million (2018: £2.3 million) and RPI inflation swaps with a value of £(0.3) million (2018: £(1.6) million).
The derivatives shown in the tables only cover those expressly held for the purpose of reducing certain undesirable asset and liability risks. The schemes also invest in a number of other pooled funds that make use of derivatives. No allowance is made in the figures above for any derivatives held within these, as these are not held expressly for the purpose of managing risk. The total fair value of pooled funds held within the schemes' assets was £582.0 million (2018: £567.4 million).
Movements in the fair value of the schemes' assets were as follows:
|At the start of the year||3,842.9||3,863.0|
|Interest income on schemes' assets||98.4||97.7|
|The return on plan assets, excluding amounts included in interest||58.5||(60.0)|
|At the end of the year||3,909.1||3,842.9|
The group's actual return on the schemes' assets was a gain of £156.9 million (2018: £37.7 million), principally due to gains on derivatives hedging the schemes' liabilities.
Movements in the present value of the defined benefit obligations are as follows:
|At the start of the year||(3,498.7)||(3,615.5)|
|Interest cost on schemes' obligations||(88.9)||(90.6)|
|Actuarial (losses)/gains arising from changes in financial assumptions||(160.6)||85.1|
|Actuarial gains arising from changes in demographic assumptions||70.9||43.2|
|Actuarial (losses)/gains arising from experience||104.2||(18.1)|
|Current service cost||(6.2)||(27.3)|
|At the end of the year||(3,425.2)||(3,498.7)|