Share prices hit by DB deficits could spur fresh derisking drive

The report, compiled by Llewellyn Consulting and funded by the Pension Insurance Corporation, added to mounting fears that UK businesses are being penalised by markets for operating legacy DB schemes.

Public companies disclose pension deficits on an IAS 19 basis when publishing their accounts, which uses a discount rate derived from the yield on high-quality corporate bonds.

But the PIC study found that investors tend to add a risk premium of around 20 per cent to this figure when valuing a business, leading to a lower overall market capitalisation.

There’s actually levers for these companies to pull that will enhance the value of the company

Hugh Nolan, Spence and Partners

This revised assessment produces a figure broadly consistent with measuring the deficit based on a risk free rate of return, somewhere between the accounting standard and the full buyout measurement used by insurance companies.

“It would appear that investors are, by design or just chance... factoring in the fact that a pension plan will cost more to deal with than is being disclosed in the accounts,” said David Collinson, head of strategic development at PIC.

The findings also suggested that even where companies report a small deficit or a fully funded scheme, investors continue to apply a similar discount to valuations.

“Those employers that do have pension plans clearly are not as liked as those that don’t,” said Collinson. He said he expected the increased difficulty in raising money to incentivise employers to tackle their deficits.

Not all bad news

At face value, the results lend credit to the suspicion that DB deficits are beginning to stifle British businesses. The study captures results up to March 2014. Deficits have ballooned since due to compression of yields, and events including a further round of quantitative easing and the Brexit vote.

The Bank of England’s Ben Broadbent has denied that QE has had a “material” effect on pension schemes and the employers that sponsor them, despite plastics manufacturer Carclo warning in August that its final dividend was under threat due to its deficit.

Source: The DB Pensions Analytical Database/Llewellyn Consulting

But scheme sponsors may be able to take some positives from the findings. Collinson noted that derisking of scheme assets will have a corresponding effect on employer share price.

“The markets say I can spend 20 per cent more than the liabilities and I’ll still be on a neutral footing,” he said.

At a more basic level, companies whose valuations are currently depressed will see their situation improve, as pensions are paid out over time.

“Those liabilities will reduce and therefore naturally their stock price will grow faster than those who haven’t [got a pension scheme],” said Hugh Nolan, director at consultancy Spence and Partners and president of the Society of Pension Professionals.

He added: “There’s actually levers for these companies to pull that will enhance the value of the company.” Examples might include encouraging members to transfer out of the scheme, a derisking move that costs significantly less than insuring the liabilities on a full buyout basis.

Boost for bulk annuities

Investors’ distaste for pension deficits is also likely to spur increased activity in the bulk annuities market.

The PIC study found that the 20 per cent discount means a company with a large pension scheme in relation to its size will see its market cap suffer more than a company with a small scheme, even if the funding positions are similar.

Schemes and employers might therefore see share price rise as a result of derisking exercises such as buy-ins.

Alan Baker, UK DB risk leader at Mercer, said: “I think the heightened focus on pension deficits is going to increase the focus on reducing or eliminating those risks from corporate balance sheets.”

He continued: “Certainly we are seeing the pipeline of bulk annuity and longevity-hedging cases increasing. The start of the year was slow but now things are really picking up.”