Bonds to the rescue? It’s a blip
The numbers pack a punch. In the autumn Mercer reported that the pension fund liabilities of the top 50 mainland European companies totalled £72bn - compared with a £45bn funding gap for their UK FTSE 100 counterparts. Notably, pensions risk exposure in Germany’s Dax 30 companies was 20% higher than in their UK and Dutch counterparts and treble that for French firms.
Since then, it seems nothing much has changed. “Broadly speaking, the situation is no different,” says Tim Keogh, worldwide partner at Mercer. “Deficits have tended to rise. It’s a pan-European effect.”
Yet this neatly segmented European landscape belies cross-border bleed of risk associated with pension liabilities.
Much of their multinationals’ pension exposure lies outside their home country. French companies may have little pension exposure in France, say, but significant liabilities through subsidiaries in the US, UK and Germany, where defined-benefit provision is far more prevalent.
“European markets are less polarised than you might expect,” Keogh acknowledges. “There’s a bias attributable to where the company is based but it isn’t an extreme bias.”
In any case, assessing corporate pension funds’ liabilities across European markets is a precarious business because of the patchy availability of credible data.
It wasn’t until the end of November, for instance, that the Dutch trade association of private insurance companies agreed to deliver data on pension liabilities. The data won’t be published until the end of 2007 but the fact that it hasn’t to date been gathered or analysed, even though 95% of insurers are members of the association, is telling.
The Netherlands is not the sole culprit, either. In the UK, it took the appointment of a pensions regulator to do the maths, and the regulatory push towards universally reported liabilities - the UK regulator previously called it a ‘data-free zone’ - will make a difference. “It’s a problem for public policy,” says Stephen Yeo, senior consultant at Watson Wyatt. “The problem is that it hasn’t been anyone’s job to collect it. Only once you see the scale of the deficit can you get the policy responses.”
Even where reasonably credible data is available, the pan-European figures cover significant intra-market complexity. In the UK, for instance, a small number of large companies funded the £4.5bn that went into cutting their deficits.
The issue is the size of scheme relative to the size of the business. According to the Mercer study cited earlier, Dax 30 company pension deficits represented 12% of company value, compared to 4% in France, 3% in the UK and 2% in the Netherlands.
According to Yeo, the average company with a pension deficit could pay it off with less than six months’ worth of profits. “For every company that can do it, another one is in serious trouble,” he says. “For the average company, it’s not a problem. For a few companies - those with a big history and a small business - it’s a real problem because the pension fund is massive compared with the business.”
Similarly, in Germany, pension funds’ liabilities are more complex than the overall figure suggests. “Some companies fund their obligations - at least partly - in external funding vehicles such as pensionskasse, and direct insurance and support funds,” says Klaus-Dieter Rauser of German consultancy Rauser Towers Perrin. “A second group of companies have pension obligations via a direct pension promise.” The book reserves of this second group, which comprises around 65% of the German pensions market, “indicate only assumptions that are sure at date of calculation, so future developments or trends (the best-estimate approach) are not regarded for the German balance sheet”.
While German companies are not required to fund their pension schemes, there are good reasons to plug the gap - not least the negative impact of liabilities on credit ratings. Rauser Towers Perrin’s most recent study shows an annual increase in the average funding ratio to its current 56%. “Beyond this our experience shows no country-specific differences any more,” he says.
Crisis, what crisis?
There seems to be a fair swathe of optimism - at least among advisers. A second survey by LCP argued that, in the UK, FTSE 100 companies would clear their deficit by 2012, with 30 FTSE 100 companies needing to add annually €1.9bn for the next decade to do so.
So why worry? Because this risk, points out Paul McGlone, head of propositions for financial risk consulting at AON, is systemic. McGlone, points out that pension funds are managing risk trends that they can neither control nor predict.
In November, for instance, a 0.1% increase in bond yields resulted in a 10% (£6bn) decrease in pension deficits, according to AON research. Similarly incremental movements over the year led to a 40% drop in overall deficits to £46bn over the course of the year.
Asked what the figures tell us about long-term trends, McGlone replies: “Absolutely no idea - it depends on the markets. If equities are up, it’s good; if they’re down, it’s bad. The same goes for bond yields. It means that today’s guess is as good as any.”
Yet it would be a mistake to see this as a financial force of nature out of the control of companies and their pension funds. In investment management, Keogh sees schemes in the UK, as in the rest of Europe, moving into swaps and derivatives “to mitigate the downside and capture the upside”.
Companies can also cap their liabilities. Yeo cites Rentokill’s 2005 decision to cap its pension fund liabilities by closing the final-salary scheme for existing employees and plugging the fund with £200m. Other companies are looking at solutions that fall slightly short of it - for instance, British Airways’ decision to up its retirement age.
But before the pollsters get carried away with optimism, it’s worth bearing in mind that a quarter of companies in mainland Europe think their pension funds are a serious risk to their continued operation.
According to yet another (December) Mercer survey, UK firms fare worst, with 29% concerned about their pension plans compared with 24% in continental Europe - possibly reflecting the fact that average UK pension exposure is double that of the US. Rising bond yields or no, this is no time for complacency.