The number of profit warnings issued in the first half of the year from UK-listed companies with a Defined Benefit (DB) pension scheme has increased by 70% year-on-year (y/y), from 20 in H1 2021 to 34 in H1 2022.
The latest profit warning analysis from EY-Parthenon reveals that a quarter (25%) of all UK-listed companies’ warnings issued in H1 2022 came from firms sponsoring a DB pension scheme. Across all listed companies, 136 profit warnings were issued in H1 2022, 34 of them from firms with a DB pension scheme. In the second quarter of 2022, 15 warnings from companies with a DB pension scheme were issued, down slightly from the 19 issued in the first quarter, yet more than double the seven warnings issued in Q2 2021.
The majority (26) of companies with a DB pension scheme that issued a profit warning in H1 2022 were from consumer-facing (19) or industrial sectors (7), including FTSE Personal Care, Drug and Grocery Stories, FTSE Retailers, FTSE Food Producers and FTSE Industrial Support Services.
These are among the sectors most adversely affected by cost pressures and supply chain disruption, in addition to being particularly susceptible to declines in business and consumer confidence.
Rising overheads, including increased energy, fuel, wage, and material costs, were cited as the main reason for companies with a DB pension scheme issuing a profit warning, with a record 60% of firms claiming this in Q2 2022, up from 53% in Q1 2022. This was followed by supply chain disruption, which accounted for 33% of warnings, up from 26% in Q1 2022.
In the first six months of 2022, the overall number of profit warnings issued by UK-listed companies increased 66% y/y, from 82 warnings in H1 2021 to 136 warnings in the same period this year.
Karina Brookes, UK Pensions Covenant Advisory Leader and EY-Parthenon Partner, comments: “Listed companies with DB schemes have a highly complex set of challenges to navigate throughout the second half of 2022 and into next year. The past six months have shown that the difficult macroeconomic environment is adversely affecting these companies, particularly those in the retail and industrial sectors, which are most sensitive to rising costs and supply chain disruption.
“With growth stagnating, and significant increases in both inflation and interest rate rises likely to continue for the rest of the year, the outlook for sponsors’ cost bases is unlikely to improve markedly in the short-term. It is therefore vital that trustees continue to monitor the strength of the employer covenant over the life of the scheme and identify any early signs of distress.
“To ensure the security of member benefits, trustees need to undertake robust scenario planning to gain a complete understanding of the sponsor’s exposure and any potential impact on performance – this includes current, short-term factors as well as risks that span the entire life of the scheme. This process will help to determine whether interventions such as security or non-cash contributions should be sought from the sponsor to balance any additional risks to the covenant.
“Overall, corporates have many competing stakeholder demands, including from the trustees. They will need to manage these carefully, not least given the Pensions Act 2021, and ensure that the scheme is considered equally among other creditors.”
Eimear Kelly, EY-Parthenon Head of Pensions Alternative Financing Solutions, adds: “Despite the economic headwinds that many corporates are facing, there has actually been a year-on-year improvement in the funding levels of DB pension schemes. The PPF 7800 Index indicated that the aggregate surplus of the UK’s DB schemes increased to £267.9bn in June 2022, up from £104.7bn in June 2021, largely driven by increases in gilt yields. Inflation expectations have increased over the past year, although annual inflation increases applied to members’ pensions are typically capped and pension scheme liabilities are unlikely to be fully exposed.
“Due to the improvements in funding levels and the risks and challenges looking forward, we are seeing more corporates and trustees discuss how to lock in improvements alongside managing the risk of overfunding the pension scheme in the future. Whilst a surplus sounds like a nice problem to have, it restricts how sponsor capital is best allocated, as pension scheme funding can be a one-way valve; once money is paid in it is notoriously difficult to extract and attracts penalty tax charges. This means a balancing act is needed to ensure a scheme is neither under nor over funded, especially in the current challenging market. For many corporates and trustees, the use of a structured vehicle which sits outside of the corporate net is one of the best ways to achieve this, offering an innovative, agile and secure solution for both parties. It allows companies to efficiently manage capital, as the structure will funnel money into either the pension scheme or the company as needed, whilst trustees and schemes are able to benefit from the security of a vehicle that provides adequate funding and is bankruptcy remote from the corporate.”
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