Corporate pension funding under renewed spotlight

Defined benefit funding by corporations is taking on renewed urgency for regulators, pension funds and companies themselves as the potential for deficits to interfere with corporate life becomes more acute.

The issue is particularly significant in the U.K., said sources. But DB funding is also on the agenda for U.S. companies, as premiums paid to the Pension Benefit Guaranty Corp. begin to bite into company balance sheets.

“Premiums have been skyrocketing the last 10 years,” said Alan Glickstein, Dallas-based senior retirement consultant at Willis Towers Watson PLC. “We have seen an incredible increase on the burden on plan sponsors related to this premium, many millions of dollars — plans that are healthy, companies that are healthy” and unlikely to need to make a claim.

PBGC premiums increased to $64 per plan participant in 2016. They are to rise to $69 in 2017 and that will rise to $74 in 2018, $80 in 2019 and will then be indexed.

Besides the PBGC issue, some companies are comfortable with running a deficit to some degree, he added. And there is even a debate whether there is a deficit, based on how that is measured. “If you can spend the money ... more effectively somewhere else in the business, you can make a pretty good case that rather than make (a pension fund) look fully funded and risk being overfunded and not getting it back,” you instead spend it elsewhere to help the business, Mr. Glickstein said.

Channeling spare cash into pension funds is also under increased scrutiny at U.S. corporations as pension federal funding relief reduces. “Going into the future, as the funding relief is reduced, it looks like corporations will have to start putting money into their plans due to lower discount rates,” said Ned McGuire, vice president and a member of the pension risk solutions group at Wilshire Consulting, an arm of Wilshire Associates Inc., Santa Monica, Calif.

“I'm not sure where that money will come from. ... Whether (companies) take away from dividends will be a corporation-by-corporation call,” Mr. McGuire said Wilshire's clients are aware that their cash contributions might increase in the future due to the reduction.

In the U.K., the interplay between deficits and dividends is high on the agenda for politicians. Speaking at the annual conference of the Pensions and Lifetime Savings Association in Liverpool, England, in October, Richard Harrington, the parliamentary undersecretary of state for pensions who was appointed to his role in July, said of pension fund liabilities: “As a businessman of quite a few years, I don't understand why companies should think it's not their liability. If you are a board, why isn't it the same as a wage bill. ... It is still a liability for the company. I don't understand the mentality of boards saying, "Well, it's not quite the same as any other liability we have got.'”

He said that, at the point of recruiting employees, part of the deal is a salary, a bonus and a pension fund.

“I don't actually buy that there's a conflict between dividends and paying up pension schemes at all,” Mr. Harrington said.

“There is a conflict between everything and dividends, every other expense of a company — why are pensions so different?”

Research last month by IHS Markit showed that 20 companies in the FTSE 350 have a pension fund deficit that could affect dividend distributions. Five of those companies are listed on the FTSE 100 index.

A separate study by Pension Insurance Corp. and Llewelyn Consulting showed there is an impact of pension fund deficits on the market value of companies — broadly consistent with the market attaching an additional risk premium equivalent to an average 20% of disclosed pension obligations.

The hot topic in the U.K. right now relates to calls for The Pensions Regulator to be granted the power to potentially block merger-and-acquisition transactions should a deal adversely affect a pension fund and the fund is not sufficiently funded.

In responses to the U.K. government Work and Pensions Committee's investigation into the country's 6,000 DB funds and their regulation, the regulator suggested a mandatory clearance process for certain business transactions, with new obligations for sponsoring employers regarding business actions. The clearance process now is voluntary.

“We think directors of a company have a statutory duty to consider the interests of pensioners,” said Peter Swabey, policy and research director at ICSA: The Governance Institute in London.

However, the shape that takes is not necessarily to have the ability to block transactions. “The last thing you want to do is to stifle the possibility of a transaction because TPR has the ability to block deals, as that will potentially drive investment away from companies,” Mr. Swabey said.

Gary Squires, managing director in London at global business advisory firm AlixPartners, warned that unless the regulator “is significantly better resourced and moves to help streamline the process, (compulsory clearance) could stifle commercial enterprise, which could result in significant criticism and undermine the regulator.”

Mr. Squires thinks the regulator should instead make greater use of an existing resource, the skilled persons regime, which could see the regulator delegate its powers of inquiry.

“So if the regime remains voluntary, parties can go to seek absolution, but if they don't then they run the risk of the regulator appointing someone to analyze the transaction, identify any problems, and suggest options for mitigation.” The costs would then be paid by the parties involved in the transaction, rather than the levy payer.