The market in pension fund liabilities Thursday, May 08, 2008
FT Alphaville had a report recently on companies offloading their pension obligations
More of the UK’s 100 biggest listed companies are looking to get rid of pension liabilities as the price of offloading their risk has fallen. At least 10 FTSE100 companies are seeking bids from insurance firms that specialise in taking on retirement obligations, including seven that have schemes with assets of £1bn or more, according to a report by Lane Clark & Peacock, the actuarial consultants. The report, issued Wednesday, said the £4.1bn that companies offloaded to insurers in the six months to March 31 was seven times the figure in the preceding six months.
This is a fascinating area, since the big attraction to a company of selling it's pension fund is that their existing liability to fund a scheme can be capped/fixed. With depressed markets and changes to tax in relation to pension schemes, many schemes were pushed into deficit [forecast liabilities to pensioners exceeded forecast pension fund assets]. Legislative and regulatory changes in the UK meant that companies had to address how these deficits would be funded, but
a) the deficits in some mature schemes represented a substantial proportion of the market value of the company; and
b) depressed market meant raising finance to fund such deficits was problematic, especially since such fund raising did nothing to grow the underlying business
A growing number of companies were facing this issue and it began to overshadow their normal activities. Indeed, one joke in the City was that British Airways, via its pension fund, was a hedge fund with a struggling airline attached. The greatest concern was that companies had no easy way of capping their liabilities and, perversely, these liabilities could drive the companies into insolvency if they continued to grow. In this scenario, pensioners interest would be materially harmed.
For companies, their risk falls into two broad areas, namely
- investment risk [pension assets won't grow sufficiently to fund liabilities]; and
- mortality risk [pensioners will live longer than expected and hence draw a pensions for longer thus draining the fund]
As consequence of this, there has been an enormous shift in the UK from defined benefit to defined contribution pension schemes under which employers agree to pay defined contributions into a scheme but the employee bears the investment risk related to what the pension fund will be worth at retirement. Many existing defined benefit schemes have been closed to new members, with pressure placed on employees to switch into defined contribution schemes.
To obviate their ongoing investment risk on existing funds, companies have been presented with opportunities to fix/cap existing pension deficits by insurance-like firms who offer to assume the ongoing risk.
Firms such as Paternoster set up ready to benefit from the resultant opportunities, but few deals actually materialised. As the FT mentions, the main deterrent up until now has been the high cost to a company of offloading its pension fund since acquirers need to be compensated for the risks they are assuming. However, rising bond market yields have caused forecast deficits to shrink thus encouraging firms to sell.
For the buyers, the main appeal of the deal is to widen the gap between the assets of the pension funds and the liabilities in their favour. Several things can assist this process
- improved investment returns via more aggressive management of the funds
- encouraging pensioners to cash-in early at a net present value that is less than the payout foreseen were the pension run its lifetime. Many pensioners value cash now rather than a delayed payout, as it seems many people expect to die sooner than they actually do and hence they believe it to be a better deal.
- hedging mortality risk so that that increased costs of extended lifetimes are covered/capped
- At 10:26 AM, Feroz said...
There are three distinct risks you must guard against; they are business risk, valuation risk, and force of sale risk.Investment Risk
- At 10:49 PM, said...
As a British airways employee I am worried about my pension.
I am tempted to opt out early and start to draw it.
Would it be better for me to remain in the pension?
If it is sold on, would I benefit from waiting?
Any comments greatly appreciated