New data issued by Mercer has highlighted the scale of pension risk facing multinationals in Europe. According to the consultancy, while corporate earnings have increased since 2008, Defined Benefit (DB) pensions are still causing a significant dilution of company earnings and are now larger relative to market capitalisation than in 2006. Pension expense now accounts for around 10% of earnings and pension deficits represent 4.8% of market cap in 2010/11 compared to 2.9% in 2007/8.
The research into multinationals’ pension exposure is part of a project being undertaken by Mercer to investigate how companies manage their cross-border pension risk. Mercer has analysed six years worth of reports and accounts for 228 companies listed on the Eurostoxx 600. The research focused on companies with pension liabilities above €500m to assess the scope, extent and implications of multinational pension exposure in Europe.
“DB pension plans sponsors across the globe are accelerating efforts to manage their pension risk and ultimately transfer it to external parties,” says Julien Halfon, Principal at Mercer and author of a white paper on managing cross border pension risk: “However, this is a slow process and in the meantime, many companies still do not have proper oversight and governance of pension schemes risk. A company operating in just one market is exposed to a range of risks that need monitoring: investments, contributions, changes in liabilities and changing regulations, policies and strategies. In contrast, a multinational must deal with the compounded effect of all these issues across different regulatory and pension regimes and in a number of currencies. This can introduce significant risk and volatility at the corporate level and can hurt key financial metrics, which are of interest to analysts and rating agencies. Therefore, for multinationals, pension scheme governance and risk management must be considered together.”
“There are several key stages in the establishment of a multinational pension risk management framework,” said Mr. Halfon. “First, companies must be sure who should assume overall accountability for this area. It is crucial that this is seen as the main priority. Establishing ownership leads to the creation of policies and processes which, in turn, leads to the establishment of central and local investment and risk management strategies. Implementing regular assessments of changing risk levels within a well managed governance framework must be supported by regular communication with all advisors and internal stakeholders. Not maintaining this oversight will often lead to companies falling foul of changing local regulations or failing to address the pensions challenge.”
Deficits and funding levels
Although assets and liabilities have fluctuated since 2006, funding levels for the Eurostoxx 600 have remained relatively stable. The overall funding level was 81.7% for 2010/11. Total liabilities increased from €1.17 trillion in 2007/8 to €1.29 trillion in 2010/11 whilst total assets increased from €1.01 trillion in 2007/8 €1.06 trillion in 2010/11.
Since the 2008 credit crisis, there has been a notable increase in the size of pension deficits relative to market cap: from 2.9% in 2007/8 to 4.8%% in 2010/11. The data has highlighted some interesting information for industry sectors and countries. The Cyclical Consumer Goods sector has the highest pension deficit to market cap at 12.7%. The lowest ratio is 2.2% in the Communications and Non-Cyclical Consumer Goods sectors. German companies have the highest level of pension deficit relative to market cap at 11.7%, followed by French (7.7%), UK (3.1%), Dutch (2.1%) and Swiss companies (1.8%).
“Because so many of the large European companies are multinationals, they remain exposed to pensions even if the pension systems in their home country do not rely on private defined benefit pension structures as in the UK, the Netherlands or the US,” added Mr. Halfon. “Foreign exposures drive a large part of the pension issues for these multinationals.”
Country and sector exposure
Overall, the data showed that companies had multiple exposures across the globe in a wider range of countries than might have been expected. Thirty-five percent of companies had exposure in the Eurozone, 27% in non-Eurozone Europe, 16% in North America and 22% elsewhere. On average, European multinationals have pension exposure in at least three countries beyond their own. Companies headquartered in the UK and Switzerland have average pension exposures in less than 4 countries. Those in France have exposure to 5, in Germany, 4 and in the Netherlands, 5. These five countries account for 90% of total pension liabilities and 91% of total pension assets.
Among the large sectors, reflecting the cross-border nature of their businesses, Basic Material companies have on average pension exposures in an average of 4 countries as do those in Financials, Industrials and Non-Cyclical Consumer Goods. Companies in the Cyclical Consumer Goods sector have exposure in less than 4 countries on average. These five sectors account for 75% of total pension liabilities and 74% of total pension assets.
Contributions
The absolute amount of contributions paid by these companies to their pension schemes has remained stable – €42 billion in 2006/7, €46 billion in 2007/8, €44 billion in 2008/9, €43 billion in 2009/10 and €44 billion in 2010/11 – an average of €43.8 billion a year. Interestingly, the level of contributions has remained stable even during times of reduced corporate cash flow. The ratio of pension contributions to free cash flow varies considerably across different industry sectors. In 2010/2011 contributions were 38.1% of free cash flow for Utilities compared to 3.1% for companies in the Communication sector.
According to Mercer’s Global Head of DB Risk and Senior Partner, Frank Oldham, the risks facing pension schemes are not confined to Europe.
“Many countries have significant DB pension obligations,” he says, “Plan sponsors are suffering the burden of persistently low interest rates, volatile equity markets and rising life expectancies – exacerbated by the protracted economic down-turn. Pension deficits vary significantly across many markets and present CFOs with increasingly unwelcome pension distractions. However, tackling the issue across multiple geographies is a real challenge for multinationals, as the individual components in different countries often move in different directions at the same time. Having strong governance with regular monitoring and oversight is critical to making the most of company resources.
“As organizations seek to control their obligations, we are likely to see further developments in the transfer of this risk across Europe and globally, building on the increasing number of longevity deals and annuity purchases - which, just 6 months into the year, already looks set to reach new levels in 2012.”
|
