Sainsbury's and ITV get creative to tackle deficit challenge

The aggregate deficit of FTSE 100 pension schemes hit £68bn at the end of last month, according to the latest update from consultancy JLT Employee Benefits.

“It’s a hard reality out there,” said Charles Cowling, managing director at JLT. “It’s a debt that has to be settled at some stage.”

It’s a debt that has to be settled at some stage

Charles Cowling, JLT

Sainsbury’s, the UK’s third-largest supermarket by market share, issued £500m in perpetual securities – subordinated capital and bonds that have no maturity date and pay creditors a steady stream of income on an ongoing basis – at the end of July, enabling the company to make a £125m pension deficit contribution in the first half of 2015.

A second payment of £125m is scheduled for the next financial year.

Cowling said the supermarket giant is the latest in a long line of companies to make a “chunky” down-payment on its deficit, but it is the first company he has encountered to fund the contribution using this type of debt.

“It’s quite a clever tool,” he said. “They’ve got to get the cash from somewhere.”

A spokesperson from Sainsbury’s said a lot of progress had been made in reducing the pension deficit, adding: “We carry out health checks every three years and are in the process of a formal valuation. We will provide an update at the end of the 2015-16 financial year.”

While you might like to have some of the contingent asset structures in place – things like charges over assets, letter of credit from a bank, surety bond – these things are harder to come by in situations when the covenant is already under pressure

Darren Masters, Mercer

At the end of September the scheme deficit was £473m, an improvement of £178m from March this year, driven largely by the first of two deficit reduction payments and in part by an increase in the discount rate.

Recalibrating recovery

Commercial television network ITV also recalibrated its deficit recovery plan in 2015 by agreeing a new eight-year funding plan for the main section of its DB pension scheme.

From next year, ITV will make a £60m annual contribution, around £10m lower than the current arrangement.

According to the latest trading update, the company’s aggregate IAS 19 pension deficit at the end of September 2015 was £220m, down from £285m in June.

Progress was driven by favourable movements in bond yields, a decrease in the market expectation of long-term inflation and deficit funding contributions of £12m, but partially offset by investment losses on scheme assets.

A spokesperson from ITV said: “The change in the amount reflects a more simple contribution structure”, adding that the previous agreement had included a profit-related element.

Despite a £10m annual reduction in cash contributions going into the scheme, the company is now targeting deficit recovery in March 2021 rather than March 2025.

Shifting risk profile

Darren Masters, partner and head of Mercer’s covenant consulting group, said it is “critical” for trustees to consider how changes to deficit funding arrangements will impact a scheme’s risk profile.

“If you’re getting less contributions in, or maybe the same amount in over a prolonged period of time, does that change the risk profile in terms of the relationship between the scheme and the employer covenant?” he said.

Masters said that in scenarios where the sponsor covenant is weak or in decline, trustees have limited options for guaranteeing security via alternative means.

“The further you move down the distress curve, while you might like to have some of the contingent asset structures in place – things like charges over assets, letter of credit from a bank, surety bond – these things are harder to come by in situations when the covenant is already under pressure.”

Heavyweight negotiators

Steve Delo, chief executive at independent trustee company Pan Governance, said trustees must be “heavyweight negotiators” when heading into funding discussions with sponsors.

A clear “battle plan” is critical to negotiating with employers, many of whom will be well-versed in the complexities of business discussions.

“As a board of a business would do, it’s important to determine what your ideal outcome [is], what’s your walk-away point when you won’t do a deal and where in between the two could you land?” he said.

Lay trustees came under fire at the end of last month as research from the Pensions Regulator suggested schemes with only professional trustees are better run.

Delo rejected a view that the lay trustee model is broken but conceded many lay trustees are struggling under unprecedented volumes of work.

“A lay trustee that isn’t prepared to do the learning and won’t commit the time is going to struggle massively and be suboptimal – but there is no reason lay trustees can’t be up to this if they’re up to the [technical] challenges,” he said.