The pensions hole – can a loan work?

Never a borrower be

Is it right for companies to borrow to cover pension deficits? This question
bundles together some complex assumptions based on a narrow view of time and

The first assumption is that the deficit is quantifiable. But there are
several ways to measure the deficit of a scheme. The ‘buy out’ basis, for
example, is the figure an insurance company would charge to buy out the benefits
for the scheme members.

The second assumption is the figure that would be required to secure pension
protection fund benefits, which come to approximately 90% of scheme benefits
assuming no further accrual of funds.

A third assumption is the FRS17 accounting standard definition. But the
prescribed actuarial assumptions that must be employed in calculating the
deficit using this measure do not fit with ‘younger’ final salary schemes, which
are still open and taking members’ contributions.

Lastly the statutory funding objective introduces a scheme-specific funding
plan with the first intimation that the period over which any deficit is to be
recovered becomes a critical part of the equation.

The introduction of time into the equation has been driven by recent
consultation documents from the pensions regulator. It has suggested a ‘trigger
point’ for schemes that, on an FRS17 basis, look to have a recovery period that
is greater than 10 years.

Even if these uncertainties could be overcome, I question the wisdom of banks
lending to fill the deficit. What security do they hold? Over what period is
their loan to be repaid? And how is the loan to be applied?

Trustees seem to have been scared into a lemming-like pursuit of long-dated
government gilts. The stampede seems to have pushed the value of such assets to
an historic low rate of return. This form of investment will not reduce current
deficits. And transferring assets into this low performing class will result in
a mismatch between loan servicing for the employer and an inadequately
performing scheme for trustees and members. Clearly, a no win situation.

Steve Priddy is a member of ACCA’s corporate sector network

Control your own destiny

Most finance directors are concerned about how to control costs – and
pensions are no exception.

In recent years, pension scheme deficits have been a major headache that they
have struggled to control, mainly because trustees will always come back
cap-in-hand whenthings go wrong. But trustees and employers face a minor
conflictover their pension funding deficitsand how they are shown in the
employers’ accounts.

Some employers look at the pension scheme as a loaded gun and may find more
comfort borrowing at a set rate of interest in the market – borrowing being in
the form of debentures rather than bank borrowing. A debenture may show up more
favourably in the balance sheet than the deficit of a pension scheme.

That said, it may not be appropriate to clear the deficit with one single
payment just in case investment returns pick up and the deficit turns into a
surplus. So why borrow more money than is really necessary when more favourable
investment returns may return the scheme to fully funded in the future?

Employers may feel that to fund a deficit in full using borrowings isn’t the
best answer. So why not look at borrowing funds at a set rate, holding the funds
in an escrow account to protect the trustees.

This allows companies to drip additional capital into the scheme when
necessary, but the employer reaps the benefits of investment returns improving
in the pension because they see the deficit reduce through improved performance.
It also allows employers to hold funds in suitable investments within the
company. Where they can also benefit from gains whilst servicing the debt in a
controlled manner.

Employers will obtain control over their pension scheme deficits through
gearing. They can then satisfy pension trustees over the deficit by either
paying it off immediately or holding funds in a protected account.

They could even take theopportunity to wind up a scheme and control future

Steve Osbiston is regional director of Baker Tilly Financial

Related reading