Pensions and capital markets
Pension deficits: the financial impact on FT350 companies
Michael Pogue, University of Ulster and Donal McKillop, Queen's University Belfast .
The ‘perfect storm' of negative equity returns and low interest rates in the early years of this millennium has resulted in the majority of defined benefit pension schemes experiencing a deficit whereby the liabilities of the scheme exceed the assets.
According to recent figures (Lane and Peacock 2006), the aggregate FTSE100 deficit for defined benefits schemes (operated by 92 of the companies) was £36 billion in July 2006 compared with £35 billion at the end of July 2005. However these figures obscure significant volatility with the deficits hitting a high of £54 billion in January before falling to £29 billion in April 2006.
These deficits are debt-like in nature although some differences do exist: a significant difficulty being that of measuring the value of future liabilities of the pension fund making numerous assumptions regarding, inter alia, wage increases and mortality rates within each scheme. Accepting that pension deficits are equivalent to debt then there are further implications for estimating aggregate debt and, in turn, corporate gearing. Emanating from such implications is a question regarding the perception of such deficits by the financial markets in terms of credit ratings and equity returns.
The research involves:
- A review of the composition of pension funds, incidence of pension scheme deficits and their volatility for large UK companies during the past five years. (FT350)
- An econometric investigation of the impact of pension scheme deficits upon both the corporate debt rating and the equity beta rating of the companies in question.
- Case studies of a selection of the FT350 companies to explore pension trustees' attitudes to deficits, their impact on pension fund management and their views on the impact on bond rating and market risk.
- Building on the econometric and case study evidence, an assessment from a policy perspective of the impact of ongoing legislative change to include Minimum Funding Requirements, Pension Guarantee Scheme and pension buy-outs.