Falling on deficit ears

It seems that hardly a week passes these days without the subject of pensions, and pension deficits in particular, hitting the headlines. With the spat between Messrs Frank Field and Philip Green adding a more personal element to the coverage, the subject of how best to ensure sponsors of defined benefit schemes meet their obligations seems set to be a topic that will rumble on for some time.

Such has been the uproar that accompanied the BHS pensions debacle and treatment of the former British Steel scheme workers that the Government commissioned a Green Paper into the area, culminating in its recently produced Protecting Defined Benefit Pension Schemes White Paper.

Designed to buttress the existing supports of independent trustees, the Pensions Regulator and the Pension Protection Fund, the investigation found that there was no systemic problem with DB schemes, but that the regulator ought to be given greater punitive powers in order to act as a deterrent to the errant.

In my view, this represents a missed opportunity to ensure the boards of sponsoring firms adopt the appropriate behaviours. Sure, the trustee system brings an independent eye to the issue, but if the Government was serious about ensuring senior management sits up and takes notice, then the additional proposed powers in the White Paper perhaps don’t go far enough.

An alternative solution would be to give pension creditors preferred status in the event of insolvency. Whilst this would only take effect in the event of an insolvency, the impact on day-to-day behaviour and the response from other creditors would be more chastening for the boards involved. With banks, suppliers and providers of debt finance all sat behind pensioners in the insolvency queue, this would bring a level of oversight and analysis to the issue far and above that currently provided by trustees.

With 10.5 million people still reliant upon defined benefit schemes to fund their retirement and £1.5 trillion of assets invested, though the White Paper found no systemic problems in this area, the potential for a major banana skin is clearly still in place. Whilst the Pension Protection Fund provides a safety net for those that do fall foul of circumstances, the demise of a major scheme would stretch its resources and have the public calling out for changes in law. Better to act now, rather than to react in the future.

Take the constituents of the FTSE 350 as a good example. Of the 205 companies that reported a pension liability, eleven of them had a deficit in excess of 10% of their total assets, whilst 23 had a deficit larger than 10% of their market capitalisation. In three cases (BT, Capita and Stagecoach) the scale of the pension deficit was more than 30% of the value of the entire company. In BT’s case, the last reported deficit was a whopping £9.1bn – three times more than the amount paid out altogether by the Pension Protection Fund since it was established in 2005.

For investors it’s a timely reminder, if it were needed, that the success of a company is not entirely to be found with a study of the profit and loss statement. For many analysts, the importance of a company’s balance sheet seems to have been progressively diminished over time to the point that few seem to bother with any analysis at all. Whilst this trend has been somewhat aided and abetted by those who prepare reports and accounts in their relegation of the balance sheet towards the rear of the report, those investors who fail to study it should be braced for sharp shocks that will inevitably punctuate their investment careers.

Top 10 pension deficits in the FTSE 350 (as % total assets)

Source: Bloomberg

Top 10 pension deficits in the FTSE 350 (as % Market cap)

Source: Bloomberg

Managing Director, AJ Bell Investments

Kevin began his career in the financial services industry as an Investment Analyst, eventually progressing to become Chief Investment Officer at a major private bank. He then took on the position of Group Head of Research & Strategy for a Luxembourg-based private banking group, before moving into a number of consultant roles for various investment management and banking businesses. In October 2017 he joined AJ Bell Investments as Managing Director and CIO.