A Barnett Waddingham report has revealed new evidence that a number of large UK companies are facing significant operational challenges due to their defined benefit (DB) pension deficits

The figures also point to a significant divide between companies suffering from major deficits and those successfully de-risking DB schemes.

FTSE 350 companies are currently paying £11bn per year to service a combined £48.3bn in pension deficits, an overall drop in deficit figures of some £9.8bn from 2009 to 2010. Nonetheless, a major worry highlighted by the report is a significant divide between pension funds that have got their books in order and others that are overwhelmed with deficits to the extent that they hamper the sponsor company.

The report found that the overwhelming majority of companies surveyed in the index pay pension deficit contributions that amount to less than 20% of their annual cash flow. However, some 29 companies have been forced to pay deficit contributions larger than their total cash flow in the last year, having a potentially major impact on the operations of firms at a time when credit conditions remain tight.

Nick Griggs (pictured), head of corporate consulting at Barnett Waddingham, said: "Our research shows the widespread impact defined benefit schemes are having on the businesses of some of the UK's largest companies. A small number of high profile companies are often highlighted for the size of their defined benefit pension obligations but our research shows that they are not alone."

When talking to Pension Funds Insider he warned that according to the report's figures "there seems to be a divide. The vast majority of companies are living pretty well with a pension scheme of a reasonable size and where deficit contributions need to be made they are a minor but manageable annoyance. On the other hand you have cases where the pension scheme deficit is significant relative to the size of the company and sponsors are having to divert significant contributions into the scheme that would otherwise be re-invested by the company or used to provide shareholders with better returns."

In total, ten companies in the FTSE 350 are in the unenviable position of having a pension scheme deficit that amounts to over 20% of their market capitalisations. Some 27 have pension liabilities that outweigh their entire market capitalisation.

While insurance companies are reluctant to take on the assets of funds running major deficits, the possibility exists to reduce pension risk by shifting out of equities, claims the report. Enhanced transfer value exercises, bulk annuities options and longevity swaps are other common ways of grappling with the risk associated with major deficits. 

Generation game

The report also reiterated fears of a generation divide in pension provision, with Griggs stating that "many of the UK's largest employers are now paying more per annum to plug DB scheme deficits than they are to fund the benefits earned by current employees each year."

According to the report the average costs of servicing deficit contributions amongst FTSE 350 firms was £4,200 per employee for 2010 but average actual employer pension contributions were just £2,800. There are fears that this imbalance could alienate young savers as they see older bosses retiring with generous pension pots that they have minimal chance of matching in a defined contribution scheme, for instance.

Griggs told Pension Funds Insider that "it is something that has been talked about before but there haven't been any previous statistics that show this so graphically. It's very worrying that there are 70 of the biggest employers in the UK that are paying more to clear deficits than they are to provide benefits for those in the future."

The report also revealed that 11 companies in the FTSE 350 are due to have their company accounts significantly impacted by the introduction of the new IAS19 international accounting standard in 2013. The abolition of the option to spread actuarial gains and losses rather than reflect them at the current value is to bring these off-sheet actuarial losses onto the books at these companies, with Shell set for the worst outright loss of £7 bn, albeit, as Griggs says, "any investors who read accounts carefully would already have been well aware of these costs". 

dbillingham@wilmington.co.uk 

First published 26.07.2011