Pension deficits - an increasing concern?
In August this year, the Bank of England cut UK interest rates to a record low of 0.25 basis points which means that rates have now dropped 5.5% since July 2007. As interest rates have fallen, so too have bond yields, with the ten year gilt yields dropping below 1% for the first time this year. Significantly this erosion in yield has caused havoc for defined benefit pension schemes with the funding cost of future liabilities rising substantially. The Bank of England has left open the possibility of a further interest rate cut before the end of the year. This is likely to cause more yield erosion and more liabilities for pension funds.
A recent study by accountancy firm Lane Clark & Peacock LLP (LCP) found that pension deficits for FTSE 100 companies stand at above £63bn, but the 6,000 defined benefit schemes across the UK have a total deficit of £710bn. LCP stated that UK companies should be in a strong position to fund their pension liabilities given the levels of dividends paid. This is likely to become particularly important for investors – it may lead companies to review their dividend policy if they are carrying large pension deficits.
For example, figures this year showed that Royal Dutch Shell handed £8 billion to shareholders despite figures showing that it had a £6.7 billion funding gap. AstraZeneca’s deficit was £1.9bn in 2014 but returned £2.4bn to shareholders.
This is not something that companies can ignore, as credit rating agencies treat their deficits as if they were debt. Companies with big pension shortfalls will show up as looking very indebted, and their credit rating will be adjusted accordingly. Yorkshire based manufacturer Carclo, a global supplier of technical plastics products, recently became the first company to cancel a dividend payment due to pension liabilities. Others could follow.
Earlier this year, the recently resigned pension minister, Ros Altmann signalled that this is a priority for the government, by starting the process of reviewing how schemes account for their liabilities in order to ease their pressures. Combining this with public anger towards the collapse of BHS, we could see defined benefit pension schemes on our new Chancellor’s first budget later in the year.
According to a recent FT article, the largest pension deficits in the FTSE 100 are held by GKN, BAE Systems, BT, G4S, IAG, Barclays & Smiths Group. This list is by no means exhaustive. If interest rates remain low, the size of pension deficits could become an increasing concern and this could ultimately impact the ability of some companies to maintain their dividends. This is a topic we continue to keep a close focus on.
22 September 2016