Righting pension deficits

Clearing out an old file the other day, I noticed a press clipping from January of this year that boldly stated: 'rebound in global markets rescues UK pension funds'.

It now seems a bit premature. For one thing, the UK market has been distinctly soft in recent weeks. It could be a mid-bull pause for breath. On the other hand the bull market could be over and a new bear phase beginning. The jury still looks to be out on that score. What we can say is that there are at least welcome signs of a new realism where objective stock market valuations are concerned.

Pension funds are clearly not out of the woods yet. And the headline from my original press cutting must ring pretty hollow with past and future pensioners of Turner & Newall. This venerable British company was latterly called T&N. It became part of Federal-Mogul, a US car parts business a few years back. Federal-Mogul has now gone bust, thanks largely to asbestos compensation claims that came with T&N.

The result of this bust is that some 40,000 pensioners are likely either to have their benefits frozen or, in some cases, halved because of a pension fund shortfall of some £875m. The scale of this sum is a wake-up call for both investors and employees alike. Compare that with the £400m the government has set aside for compensation in this area over the next 20 years.

You can, of course, argue that T&N is very special case, and in some ways it is. But new accounting standards make the investigation of pension deficits very easy indeed. Most sets of accounts now contain a very detailed note on pension fund data based on the FRS17 accounting standard. This makes clear the size of a company scheme's assets and the present value of the stream of future liabilities. It is by no means the case that every company has a deficit, but many fairly mature companies do, and it can be a sizeable amount when compared to a company's other liabilities, or its cash reserves.

I search in vain in the many broker reports I receive, however, for any mention of using this data as an analytical means of judging a company's value as an investment.

An underfunded pension scheme can be the result of many things, but one is bound to think back to those companies whose managements chose to boost profits when the market was good, and schemes were in substantial surplus, by taking pensions 'holidays'. In the days before awareness of the value of pension scheme assets was as high as it is now, takeovers often resulted in pension surpluses conveniently disappearing into the acquirer's accounts. Executive pensions are often in a segregated scheme, so that the people making the decisions do not have to bear the pension consequences of their actions.

So here is a practical suggestion. When a staff pension fund is in deficit, the senior executive scheme, and any special schemes for individual executives (which are normally absurdly generous by most people's standards), should surrender its surpluses to make up part of the shortfall. It should keep doing so until the deficit is eliminated. This will not completely solve the problem, of course, but it will concentrate the mind into some longer-term thinking about the appropriate level of funding a company should put into a defined benefit scheme on a regular basis.

In the meantime it is perhaps high time that the City took a look at how it incorporates pension fund data into valuation methodology for assessing companies. It should not be beyond the wit of some of those highly-paid (and generously-pensioned) investment bankers.