Smiths uses escrow to help slash £250m from scheme deficit

The global technology company – which provides products and services in areas including medical, rail, aerospace and weapons detection – has already made significant progress towards eliminating its pension scheme deficit through a stringent derisking campaign, but secured this latest deal with trustees in a push to tackle the shortfall after the last valuation.

At its peak, the Smiths Industries Pension Scheme deficit tipped the balance at £1bn on a technical provisions basis but the company, together with trustees, has now reached a position where its schemes are no longer stifling the group's performance.

Chris O’Shea, recently appointed financial director at Smiths, said: “This is a very exciting deal for the company – it’s not often you get to substantially reduce your deficit, substantially reduce your contributions and substantially reduce the risk.

“This is quite a unique set of circumstances… Smiths has been in someway defined by its pension liabilities over the last few years – I think that stops today.”

This week Smiths announced that the SIPS scheme deficit, valued at £285m as at March 31 2015, has reduced by £250m since the 2012 triennial valuation.

This is quite a unique set of circumstances… Smiths has been in someway defined by its pension liabilities over the last few years - I think that stops today

Chris O'Shea, Smiths

As part of the post-valuation agreement, in December the company signed over the pension escrow account, established in 2009, to trustees, reducing the deficit to £145m on a net basis.

Escrow cessation

O’Shea said planning around how to tackle the pension scheme deficit following the valuation had played a big part of his due diligence both prior to joining the group and since arrival.

The escrow account, termed an “elegant solution” by O’Shea, is currently valued at £153m and composed of index-linked gilts.

The early cessation of the structure, originally scheduled to end in 2020, was agreed between trustees and the company as a result of an improvement in funding.

Signing the escrow arrangement over to trustees has provided a significant boost to the scheme’s funding – now tipping over 90 per cent on an actuarial basis - and enabled further risk-reduction across the investment strategy.

“It became clear in discussions that… by reducing the deficit the trustee would substantially reduce the risk it was taking in its assets,” said O’Shea.

Risk reduction

In recent weeks trustees have begun a strategic reduction of the scheme’s allocation to equities, held largely in derivative structures.

Equity holdings in the scheme are now down to 13 per cent of total assets, down from 38 per cent in April this year.

Further deficit reduction has also allowed the company to trim its annual cash contributions to £24m, down from £60m prior to the valuation.

Charles Cowling, managing director at consultancy JLT Employee Benefits, said the agreement was a sign the scheme was in a good position.

“The need for an escrow account starts to disappear as you get better at matching your assets to your liabilities,” said Cowling.

“It’s now well funded, it’s derisked… it shows the benefit from a shareholder value perspective of having a pension scheme which is properly funded and low risk.”

Working together

Many large companies with “pretty frightening” deficits are “burying their heads in the sand” according to Chantal Thompson, partner at law firm Baker & McKenzie.

But Smiths’ progress through collaboration with trustees is a “good news story” she said.

“It’s an example of where a company and trustees have worked together to manage a difficult situation and it’s actually paid off – they’ve applied a number of solutions to get that deficit down,” she said.