FTSE350 firms have paid over £35bn into their pension schemes over the last three years with little effect on overall deficits, according to research conducted by pension consultants Barnett Waddingham. The total IAS19* deficit reported by FTSE350 companies in 2012 was £64.9bn which is only £4.1bn lower than 2009. The higher than anticipated deficit has largely been driven by the drop in corporate bond yields, which determine the IAS19 discount rate.
The research, conducted by Barnett Waddingham for the third year running, highlights the impact DB – or final salary – pension schemes are having on FTSE350 businesses.
This year’s report highlighted the impact large deficits are having on shareholder returns with 23 companies having paid more towards clearing their DB scheme deficit than they did to shareholders in the form of dividends.
Key findings from the research include:
- Over the past 4 years the average FTSE350 company has paid 53p of deficit contributions for every £1 of dividend paid to shareholders.
- For 6 companies the DB scheme deficit exceeds 20% of the market capitalisation of the company after removing the pension scheme liability. These companies look the most at risk of becoming the Pension Zombies of the future.
- While DB scheme deficits have decreased marginally as a proportion of market capitalisation, there were 26 companies whose pension scheme liabilities exceeded their market capitalisation highlighting the significance pensions funding will play in the future performance of these companies.
- 74 companies were paying more to reduce DB scheme deficits than they were towards future pension provision for current staff.
- On average FTSE350 companies paid nearly £4,000 per employee to clear DB scheme deficits an increase of 15% compared to 2011. By comparison, the cost of providing future pension provision for current employees, including defined contribution arrangements, remained static at £2,600 per employee in 2012.
- In 2012 there were 13 FTSE350 companies who paid deficit contributions that were greater than 30% of operating profit.
- For 32 companies it would take over a year to repay the DB scheme deficit if all cash generated from day to day operations was used solely for this purpose.
- For 19 companies, despite an implied IAS19 deficit recovery period of less than 5 years, deficit contributions exceeded free cash flow.
- Had the revised IAS19 standard been adopted by all FTSE350 companies in 2012, this would have increased the P&L charge by approximately £5.1bn (or 2.6% of profit before tax).
The research project, carried out with input from the Centre for Global Finance at the University of the West of England, will allow businesses with DB schemes to benchmark themselves against their peers.
Head of Corporate Consulting at Barnett Waddingham, Nick Griggs, commented:
“As businesses plan for the future it is often the uncertainty around future contribution requirements to DB pension plans that is as much a problem as the absolute amount that is currently being paid. This is highlighted by the persistence of large IAS19 deficits despite significant contribution payments and the resistance employers will face from scheme trustees should they want to reduce contributions if cashflow worsens.
"The Pensions Regulator’s new statutory objective should help to reduce the impact pension scheme deficits have on the sustainable growth of employers. Our research emphasises the considerable volumes of cash DB scheme deficits are consuming and the knock on impact this must be having on investor returns and companies' growth plans.
"With so many areas of uncertainty, such as the future for Quantitative Easing and how it may be extended or unwound, the development of IAS19 deficits in the short term remains as unpredictable as ever - the incoming Governor of the Bank of England, Mark Carney, has signalled a desire to provide some guidance on the future path of interest rates which will hopefully stabilise the IAS19 discount rate which has caused so much volatility. All other things being equal, it would only take around a 1% rise in bond yields to eliminate the aggregate FTSE350 IAS19 deficit.
"The effect of DB scheme deficits is being felt beyond just companies and their direct shareholders. Current employees in DC schemes are being hit by a double whammy - DB scheme deficits are consuming large amounts of company cash, which is limiting employer DC contribution levels and reducing investment returns on DC assets through reduced dividend payments.
“With the introduction of auto-enrolment, the Government has taken a small step towards closing the generational pensions saving divide that will materialise over the coming years. However, if employers are expected to provide the majority of the funding to close the gap, the cost of future pension contributions earned by employees will need to increase significantly. For businesses with a fixed pension budget this increase is reliant on deficit contributions reducing.”
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