Despite Doubling Pension Deficits, Outlook for FTSE 100 Companies Remains Positive
Although the recent market volatility nearly doubled the UK FTSE 100 pension deficits to bring them to approximately £70 billion, the outlook for FTSE 100 companies on pensions is broadly positive, according to KPMG’s 2011 Pensions Repayment Monitor.
As of the end of their last financial year, more than 75 percent of FTSE 100 companies would be able to pay off their deficit with discretionary cash flow within three years, up from just over 60 percent in the previous year’s Pensions Repayment Monitor, the research found.
According to KPMG, the pension deficit has improved as businesses’ earnings returned to higher levels of profitability, leaving them with greater discretionary cash flow from which to repay their deficits.
It has also been driven by a marginal decrease in deficits, helped by a number of factors including the government’s change to allow pensions to be indexed in line with the Consumer Price Index (CPI) rather than the Retail Price Index (RPI).
Despite the improving overall picture as shown by KPMG, companies may be questioning whether they are always receiving full “value for money” when plugging their pension scheme deficits.
“Collectively, the FTSE 100 companies paid almost £10 billion (£9.7bn) into their pension schemes, yet their overall deficit position improved by only £5 billion, from £43 billion at the end of 2009 to £38 billion at the end of 2010,” KPMG said.
“And arguably, much of this improvement was a result of the change from CPI to RPI as an indexation measure rather than a direct result of any cash injections,” it added.
“It’s very encouraging to see the financial position of the FTSE 100 companies improving however you could argue that companies are not getting maximum value for money for the contributions paid to pension schemes. 2010 was a relatively stable year in terms of market conditions yet deficits only fell by 50p for each £1 contributed by employers,” Mike Smedley, Pensions Partner at KPMG in the UK, said.
This quest for value has led to finance directors increasingly looking for new and innovative solutions to reduce risk to make sure they get full value from their contributions.
These solutions include introducing third party insurer capital to support schemes and comprehensive liability and investment management exercises designed to meet company specific objectives in reducing risk and ultimately protecting shareholder value.
Mike Smedley said, “Recent market turmoil has laid bare the limitations of just paying contributions to pension schemes if these are not used to actively take out risk.”
The KPMG analysis also showed that, should companies choose to have an insurance company “buy-out” their pension scheme’s liabilities, this was now an increasingly affordable option as their cash flows have improved and buy-out providers are currently pricing competitively.
Almost 60 percent of the FTSE 100 could fund a buy-out of their pension scheme liabilities from purely discretionary cash flow within less than five years according to KPMG’s research.
“Pension scheme liabilities remain an important issue for many of our largest companies – especially for the one in five that, according to our data, have no realistic chance of clearing them at all from discretionary cash flow,” Mike Smedley concluded.
But, despite the current roller-coaster market, the scale of the problem is diminishing for many. And while some may take a view that the time is right to look at paying for the difficulty go away, this option will still be too expensive compared to alternatives for many.
“We are therefore seeing finance directors looking for more sophisticated, bespoke insurance type structures that allow access to insurer capital but allow the company to retain and manage a portion of the pension risk,” Smedley said.