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Death and the discount rate - UK companies weigh pensions tweaks
November 21, 2017 / 9:47 AM / 21 days ago

Death and the discount rate - UK companies weigh pensions tweaks

LONDON (Reuters) - Some of Britain’s biggest companies are considering wiping millions or even billions of pounds from their pension deficits by changing a couple of key assumptions, including when staff are expected to die.

FILE PHOTO: Pensioners sit on a bench in a park in Merthyr Tydfil, Wales, May 22, 2017. REUTERS/Rebecca Naden/File Photo

Retailer Tesco (TSCO.L) paved the way last month by slicing more than three billion pounds from the pensions deficit in its accounts, citing data showing slower rises in life expectancy as well as predictions of higher interest rates.

“A lot of other companies will be asking to do something similar,” said Martin Hunter, principal at investment consultants Punter Southall.

Pension shortfalls are a common problem around the world and in Britain, two-thirds of almost 6,000 company defined benefit, or final salary, schemes are in the red, a drag on some share prices as investors worry about how they will be funded.

Improving the assumptions underlying its pension scheme gives a company more freedom to raise dividends or expand, but runs the risk of future problems unless caution is applied.

Of 22 UK listed companies contacted by Reuters, some with large deficits and some in surplus but with large liabilities, seven said they could use updated numbers for their next six-monthly accounting or more conservative triennial pension valuations.

Those among the seven with large deficits were BT (BT.L), TUI (TUIT.L), International Consolidated Airlines Group (ICAG.L), Barclays (BARC.L) and Severn Trent (SVT.L).

Two companies with large pension liabilities, but with schemes currently in surplus, Aviva (AV.L) and RBS (RBS.L), also said they may use the new longevity statistics, issued in March, and/or new assumptions for their discount rate, which fixes the money needed now to pay future pensions.

Six companies declined to comment and nine did not reply.

FROM DEFICIT TO SURPLUS

Industry-funded pension lifeboat the Pension Protection Fund (PPF) puts Britain’s collective shortfall at 150 billion pounds, a gap that can force listed companies to raise capital or cut dividends, making them less attractive to investors.

India’s Tata Steel (TISC.NS) spent more than a year trying to cut its liabilities to push through a merger of its European steel operations with Germany’s Thyssenkrupp (TKAG.DE). A large deficit has also hurt debt-laden UK construction and support services firm Carillion (CLLN.L)

Tesco said its pension fund was realigned to more appropriately reflect expected returns and had no link to its plan to take over wholesaler Booker (BOK.L).

The degree to which other companies can follow Tesco is not straight forward, though. As well as varying staff demographics, the age of the scheme, its assets and existing discount rate could all stymie the accountants’ plans.

Tweaking the number in the six-month review of liabilities in company accounts, closely watched by investors, as Tesco did, is also easier than changing the ‘triennial valuation’, a three-yearly deal with scheme trustees agreeing how much a company must add.

While Tesco’s accounting pension scheme deficit is now 2.4 billion pounds, down from 5.5 billion pounds, its triennial deficit, also published last month, has gone up to 3 billion pounds from 2.75 billion pounds, even though the company said that also took changing mortality trends into account.

FILE PHOTO: A road sign warning drivers of elderly people crossing the road is seen in Hale, northern England February 19, 2015. REUTERS/Phil Noble/File Photo

Companies have been forced to pay more into their schemes due to a decade of falling interest rates since the financial crisis, but Britain’s schemes are still only 91 percent funded, the PPF said. Those of the biggest 350 listed firms are in their weakest position since 2009, a PwC report in June said.

After the Bank of England raised rates this month, many corporate pensions advisers will be looking to reflect the brighter outlook from rising yields, said Ameet Patel, senior research analyst at Northern Trust Capital Markets.

FTSE 100 schemes had a total deficit of 36 billion pounds at end-2016, according to RBC calculations, though rising stock markets have helped their positions since then.

If every FTSE 100 company followed Tesco, using updated mortality statistics and increasing the discount rate by 0.3 percentage points, they would enjoy a total accounting surplus of 54 billion pounds, RBC analyst Gordon Aitken said.

ROOM FOR MANOEUVRE

Who is in the scheme is key.

While there has been a slowdown since 2011 in improvements in life expectancy for people in England and Wales, longevity assumptions have improved for richer men, something their employers need to bear in mind, the regulator said.

“Defined benefit schemes have a preponderance of older male members,” said Lesley Titcomb, chief executive of The Pensions Regulator. “If you have a higher proportion of affluent males in your membership, using a general assumption about longevity would not be right.”

The regulator and trustees look at the triennial rather than the accounting pensions scheme figure. Trustees may also be cautious about approving a too-big, too-quick change in assumptions in case the trend reverses.

“Are you prepared to add the more generous longevity assumptions and be proved wrong in five years?” said pensions consultant and independent trustee John Ralfe, pointing out that longevity assumptions have proved wrong in the past.

Douglas Anderson, partner, Club Vita, which assesses longevity statistics, agreed: “We shouldn’t get hung up about the last two years but about how long the trend is going to continue - for the next 30-40 years.”

Tesco’s use of estimated long-term corporate bond yields rather than its previous use of longer-dated, lower-yielding government bonds was the biggest help in cutting its deficit.

Not all schemes may have previously taken such a conservative approach, however, potentially leaving them less scope to follow suit.

While BT’s discount rate is 2.5 percent, other firms with large pension deficits such as BP (BP.L) and Shell (RDSa.L) use higher rates, of 2.7 percent and 3 percent respectively, RBC said.

And with any changes needing auditor or regulatory approval, companies will need to consider them carefully despite the “nudge” from Tesco, said Joe Dabrowski, head of investment and governance at the Pensions and Lifetime Savings Association, which represents pension scheme professionals.

”Although there’s some flexibility, it doesn’t mean you can just stick anything you want in it and magic your deficit away.

“Your assumptions will have to be grounded in realistic assumptions... They need to be in the bounds of realism and backed up by some supporting evidence.”

Editing by Philippa Fletcher

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