KPMG warns of looming pensions crunch
Despite deteriorating market conditions adding around £20 billion to the FTSE 100’s pension accounting deficits in the first half of this year, around six out of 10 FTSE 100 companies are potentially paying too much into their pension schemes, with up to half overpaying by over £20m a year, according to KPMG’s 2008 Pensions Repayment Monitor.
And the situation could get worse as nervous pension trustees, rattled by the current market turmoil, may demand more funds to shore up the growing perceived deficits.
Pensions partner, Mike Smedley, commented: “We are heading for a ‘pensions crunch’ as nervous trustees demand more cash from companies just as those companies have less of it.”
The demands stem from an understandable desire to take a more cautious view in the current uncertain economy. However, cash diverted into the pension scheme is not available to the rest of the business and KPMG’s 2008 Pensions Repayment Monitor suggests that six out of 10 FTSE100 companies are paying more into their pension schemes than is actually required to clear the deficits within a reasonable (10 years) time period.
“It’s all a question of timing,” added Mike Smedley. “At a time when cash is plentiful, using it to clear debt can be a very good idea – similar to a householder flush with cash deciding to pay off a mortgage early – but as the credit squeeze tightens, financial obligations need to be prioritised and if pensions can be met over a longer time period, that can reduce the demand for cash outgoings today. This flexibility ought to improve the long-term health of companies which is the pension trustees’ primary interest.”
Results of the 2007 Survey
The 2008 KPMG Pensions Repayment Monitor’s analysis of year end accounts shows that 70 per cent of FTSE 100 companies with defined benefit pension schemes could pay off their pension deficits (calculated at the end of 2007) in a single year using pure discretionary cash flows. This is an improvement on 2006 when 50 per cent of companies could have done so and on 2007 when the figure was 60 per cent. Over 2007, the accounting deficits of the FTSE 100 fell by around £40 billion.
And extending the time period to three years gave an even more positive figure with 80 per cent of the sample able to clear deficits in this time frame, up from 70 per cent in both the previous surveys.
In addition, the number of companies recording an accounting surplus in the 2008 sample increased to 21 compared with only 9 in the 2007 survey.
Although the proportion of those companies able to pay off deficits quickly increased, 15 per cent of the sample are unable to clear them within any realistic timeframe without diverting cash from elsewhere. For this group, pensions remain a significant challenge.
For the first time, the KPMG Pensions Repayment monitor examined the FTSE 250, where it revealed that 60 per cent of those with defined benefit pension schemes could clear their deficits from discretionary cashflow within one year and 70 per cent within three years. A limited analysis of the 2006 sample conducted for comparative purposes suggests that just 25 per cent of these companies could have cleared their deficits within one year at that time and around 50 per cent could do so over a three year period.
A trend set to continue?
The decline in the markets since the end of 2007, (the FTSE 100 index was at 6,456.90 on 31st December 2007 and at 5,477.5 on 7th August 2008) has led to an increase in pension deficits. However, close to six out of ten FTSE 100 companies are still paying more than is required to pay off their deficits over ten years.
As well as market movements, pension liabilities are highly sensitive to the assumptions made about the longevity of the current and future pensioners the scheme is providing for. The pensions regulator is putting pressure on trustees to use much stronger longevity assumptions for funding purposes which could increase total liabilities by around £40 billion.
Mike Smedley commented: “A sustained fall in the markets will inevitably lead to an increase in assessed pension deficits and increasing mortality assumptions will add further pressure. How the pension trustees react to this can have a profound effect on a company. Additional cash pumped in now may make the trustees feel better but in practice will make little difference relative to the impact of market movements and long-term company strength. Trustees are very long-term creditors and need to work with companies to develop a coherent strategy to manage pensions through these turbulent times.”
The Buyout Option
The market for “buyout” (where a company pays a third party insurer to take on the pension scheme liabilities) has grown significantly recently as a result of increased competition among buyout providers and the impact that credit conditions have had on pricing.
For trustees and companies wishing to secure pension liabilities and their inherent risk, buyout can be an attractive option. But, for many companies, a full buyout may not always offer best value or the most efficient method for managing pension risk and pension financing. A number of companies are beginning to implement actions themselves similar to those taken by those insurers offering formal buyouts to manage pension risk, rather than go to a third party to insure their liabilities in full.
Mike Smedley concluded: “Whilst a buyout of pension liabilities can be the right solution in some circumstances and many companies and pension trustees are actively considering it, buyout is not a panacea but one of many ways to tackle pension risks. In some ways buyout could even be seen as a last resort for strong companies who cannot reach an efficient funding and investment strategy with their trustees”
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