The stockmarket’s recovery has eased the pensions crisis, but few would argue
that the retirement question has been solved. It remains a minefield, not least
for companies sponsoring defined benefit schemes. Having overpromised in the
past, they are facing up to the horrendous cost of their earlier largesse.
Over the past five years, companies have been forced to deal with a
relentless barrage of horrors. Tumbling equity markets, collapsing bond yields
and growing longevity have conspired to create a yawning gap between liabilities
While the worst appears to be over in headline deficit terms, companies are
not out of the woods, and the regulatory backdrop against which they are trying
to sort out the pensions muddle has tightened materially.
Everyone knows how we got here. Between 2000 and 2003, the stockmarket lost
more than 50% of its value. Leading shares are still more than 20% below their
peak. Over the past five years, the AA sterling bond yield has fallen from 7% to
4.8%, ratcheting up the present value of future liabilities. Worst of all, from
an actuarial point of view, at least, we’re living longer.
According to analyst Karen Olney of investment bank Dresdner Kleinwort
Wasserstein, the big picture is looking brighter: ‘While the pain isn’t over, it
will be more of a steady drag on cash flow for a few sectors and companies that
were disproportionately impacted.’
Olney estimates that the current pension deficit for the FTSE100 index at
£42bn, down from £55bn a year ago. Actuaries Lane, Clark & Peacock believe
it is £37bn, while UBS has a figure of £54bn. Given the variables involved,
that’s a remarkable consensus.
Looking at the problem another way, Aon Consulting estimates that only 5% of
UK company pensions are fully funded and the average deficit is the equivalent
of seven months’ profit. Although companies have been increasing contributions,
the rises have not been enough to offset the impact of falling bond yields and
more demanding mortality rates.
Figures suggest that women currently aged 65 can expect to live until they
are 89, while men of the same age will probably make it to 86. When the state
pension was introduced, the expectation was that most people would stagger on
for a year or so after retirement.
Olney sees reasons to be cheerful but has matching concerns. She says bond
yields are unlikely to fall much further, company contributions have risen to a
more sensible level, growth assumptions are now more realistic and the overall
level of the shortfall is manageable, at not much more than companies paid out
last year in dividends.
But she worries that around half of all pension funds are yet to bring their
mortality expectations up to date. Payments to the government’s new pension
protection fund could also threaten the viability of smaller companies, and the
growing powers of pension trustees in the wake of the Pension Act 2004 could
undermine companies’ ability to act in the interests of all their stakeholders.
The simmering row between womenswear manufacturer Sherwood and the trustees
of its pension scheme illustrates the problem. Sherwood wants to pay a little
under £7m into its fund to plug an estimated £7.5m deficit, while at the same
time paying back £6.5m to its shareholders. But the trustees are worried about
the company’s future and want the pension fund closed down with all members’
pensions guaranteed at a cost of £16m.
David Norgrove, the pensions regulator, has been called in to resolve the
dispute. The outcome will be watched with interest, not least because it will
show the extent to which power has shifted from company to trustee, and what
powers the regulator has at his disposal.
Critics point out that the new pensions medicine runs the risk of working so
well it kills the patient. Two thirds of pension schemes are already closed to
new entrants. Now the National Association of Pension Funds fears that more than
half of the UK’s 20,000 final salary schemes will also close to accrual for
existing members within five years.
So how are companies responding in this new, harsher environment? First, they
are rightly taking the initiative, plugging gaps on their own terms before they
are forced to do so on someone else’s. ITV surprised most observers when it
chose to borrow £435m to pay into its pension fund – equal to about
three-quarters of its outstanding liability.
Secondly, companies are choosing to get the bad news out of the way. ICI’s
admission that its UK pension scheme deficit could rise by 63% caused a stir in
the chemicals sector.
Thirdly, some companies are selling assets to refinance their pension pots.
Morgan Crucible recently sold its magnetics division to clear an unfunded
pension liability in Germany and to give it the option of paying off its UK
pension deficit of £30m.
Finally, companies are sitting down with trustees and staff and thrashing out
a compromise solution that means everyone shares the pain. As John Rishton,
outgoing chief financial officer at BA puts it: ‘The issue is, how we can secure
our pensions without jeopardising the future of the company?’
Mike Turner, chief executive of BAE Systems, another giant company with a
giant pensions problem, said recently: ‘The company will close the actuarial
gap, but this means both the company and employees putting their hand in their
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