Despite recent market volatility almost doubling UK FTSE 100 pension deficits to bring them to approximately £70 billion, the outlook for FTSE 100 companies on pensions is broadly positive, according to KPMG's 2011 Pensions Repayment Monitor.
The KPMG research found that, as of the end of their last financial year, over 75 percent of FTSE 100 companies would be able to pay off their deficit with discretionary cash flow within three years, up from just over 60 percent in the previous years Pensions Repayment Monitor.
This improvement was driven mainly by businesses' earnings improving as they returned to higher levels of profitability leaving them with greater discretionary cash flow from which to repay their deficits. It has also been aided by a marginal decrease in deficits, helped by a number of factors including the Government's change to allow pensions to be indexed in line with the Consumer Price Index (CPI) rather than the Retail Price Index (RPI).
Although the KPMG analysis showed an improving overall picture, companies may be questioning whether they are always receiving full value for money when plugging their pension scheme deficits. Collectively, the FTSE 100 companies paid almost £10 billion (£9.7bn) into their pension schemes, yet their overall deficit position improved by only £5 billion, from £43 billion at the end of 2009 to £38 billion at the end of 2010. And arguably, much of this improvement was a result of the change from CPI to RPI as an indexation measure rather than a direct result of any cash injections.
Mike Smedley, Pensions Partner at KPMG in the UK, commented: It's very encouraging to see the financial position of the FTSE 100 companies improving however you could argue that companies are not getting maximum value for money for the contributions paid to pension schemes. 2010 was a relatively stable year in terms of market conditions yet deficits only fell by 50p for each £1 contributed by employers.
This quest for value has lead to finance directors increasingly looking for new and innovative solutions to reduce risk to make sure they get full value from their contributions. These solutions include introducing third party insurer capital to support schemes and comprehensive liability and investment management exercises designed to meet company specific objectives in reducing risk and ultimately protecting shareholder value.
Mike Smedley added, Recent market turmoil has laid bare the limitations of just paying contributions to pension schemes if these are not used to actively take out risk Buy-out. The KPMG analysis also showed that, should companies choose to elect to have an insurance company buy-out their pension scheme's liabilities, this was now an increasingly affordable option as their cash flows have improved and buy-out providers are currently pricing competitively. Almost 60 percent of the FTSE 100 could fund a buy-out of their pension scheme liabilities from purely discretionary cash flow within less than five years according to KPMG's research.
Mike Smedley concluded: Pension scheme liabilities remain an important issue for many of our largest companies especially for the one in five that, according to our data, have no realistic chance of clearing them at all from discretionary cash flow. But, despite the current roller-coaster market, the scale of the problem is diminishing for many. And while some may take a view that the time is right to look at paying for the difficulty go away, this option will still be too expensive compared to alternatives for many.
We are therefore seeing finance directors looking for more sophisticated, bespoke insurance type structures that allow access to insurer capital but allow the company to retain and manage a portion of the pension risk.
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This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.