Pension deficits

Occupational pensions are at a crossroads. With UK defined-benefit schemes known to be heavily in deficit, companies are under increasing pressure from regulators, unions, workers and the media to address the current funding gap. From an investment perspective, these deficits have been driven by a fall in equities (such schemes typically invest heavily in equities) and bond yields (arguably the matching assets for pensions are bonds). Rising mortality rates are also a factor. We are living longer than expected and, while only an actuary would tell you that this is bad news, it is one of the reasons for a rise in the liabilities, and hence the deficit.

In adherence with the Pensions Regulator policy, organisations must clear these deficits as quickly as possible, and for many companies this is likely to have a substantial, and possibly painful, impact on cashflow.

If you have a deficit, what options are open to you?

Companies in deficit will need to assess the opportunities for deficit reduction. There are numerous cases where companies have dramatically reduced their deficits by focussing on the different classes of members in the scheme. Companies should consider the nature of any guaranteed benefits, and what opportunities are there for arbitrage.

Many members of pension schemes, accounting standards and insurers place a lower value on their benefits than legislation. If offered £500 now or £50 per year for life an actuary would advise that £50 for life is more valuable. However, some would choose the £500 option, because they place a higher value on cash today than on a pension in the future.

Recently, some organisations have been able to reduce their deficit by as much as 40% using a range of creative tools similar to those above.

Companies might also consider the price at which the liabilities can be sold in the market. Insurance company quotes, for many of reasons, appear expensive and lead to an increase in the deficit. However, there are alternatives and both investment banks and hedge funds see potential arbitrage opportunities in this area.

So is there an innovative solution for all companies? There is no single answer but, with the right injection of creativity, effective solutions can be found. To succeed, organisations need to be innovative enough to challenge traditional thinking.