The combined pension deficit of all UK defined benefit pension schemes could be as high as £295 billion on 30th September 2011.
This could be made worse by the latest round of quantitative easing (QE), which could add another £45 billion to that deficit according to KPMG (kpmg.com/UK/en/IssuesAndInsights/ArticlesPublications/NewsReleases/Pages/Ballooning-pension-deficits-pile-pressure-on-distressed-companies.aspx).
This problem only applies to defined benefit schemes, which are pensions where the pension amounts are set out when you start the scheme. These are normally provided by the state and large firms. But the state does not have a problem as it can pump taxpayers’ money into the hole, whereas companies have to find it themselves or from the contributors. Without the added money the company cannot meet its future commitments and will become insolvent.
The other type of pension, the defined contribution scheme, where you don’t have an exact idea of what you get until you draw the pension despite paying in a set regular amount, has its own problems because of the current poor investment returns meaning many projections will prove to be woefully short.
“Pension funds have already taken a battering over the past few months from both tumbling equity markets and falling gilt yields, but this is set to be compounded by the second round of quantitative easing, which will see gilt yields fall even further; piling on the pressure in the boardroom” said Paul Cuff the pensions M&A partner at KPMG.
As David Costley-Wood, restructuring partner at KPMG said, a spike in the deficit like this would not normally be important as values of companies and assets move all the time. But there is a growing trend of companies becoming pension ‘zombies’, those that could be forced into insolvency should their pension deficit become a black hole sucking the life out of the company.
Pension trustees, who have a responsibility under regulation to ensure the correct operation of the fund, may as a result ask firms, which are already cash strapped, to pour more money into the fund to bridge the gap.
KPMG says that if QE has the ultimate desired effect of improving the nation’s finances then it will be good for firms in the long run. But only if they are able to survive the short term deficit. Those firms approaching a valuation shortly or are in the process of restructuring or other transactions may find it of ‘concern’.
Many firms will be hoping that both the trustees and the regulator will be understanding.
David Costley-Wood said “The board have to hope that the trustee and regulator will be sympathetic to the artificially exacerbated situation caused by quantitative easing. Moreover, they will also have to hope for the understanding of wider stakeholders such as their lenders and credit insurers. Trustees are also in a difficult situation, under pressure from the regulator to extract more cash and from companies to explain why the benefit of the cash previously put in has been lost through asset or liability movements outside their control. Of course, the size of the deficit is less important for companies which do not have a valuation for some time but those with valuations due at the end of the next quarter – particularly those in distress – will be the most worried.”
This problem will get worse though as this current economic environment continues.