How Pensions Are Hurting Industrial Companies

Pensions are throwing a spanner in the works for companies already struggling against the downturn.

(October 11, 2012) — Industrial companies in the United Kingdom have some of the worst pension fund deficits, despite efforts to reduce them, which could impact their prospects for growth and very survival, research has shown.

Pension fund deficits represent over 8% of an industrial company’s market capitalisation, on average in the FTSE350, according to investment consulting firm and actuary Barnett Waddingham.

This is the second highest percentage after consumer cyclical companies, Barnett Waddingham said, but noted that this sector has seen company share prices fall sharply as a result of a drop in spending on the high street by recession-struck shoppers.

For ever other sector, the average pension deficit was equivalent to 4% or less of the market capitalisation of the company.

This is an important consideration for company bosses when addressing financing, the consultants said, and could make it trickier for them to borrow in order to expand – or even continue to operate.

“One potential consequence for a company with a large pension scheme deficit disclosed on the balance sheet is the impact it will have on the company’s gearing ratio (a measure often used to assess financial risk or longer-term solvency),” the report from Barnett Waddingham said. “The gearing ratio can be an important indicator for companies looking to raise additional finance and the pension scheme deficit can have implications for debt covenant restrictions. At the margin, an increased gearing ratio can lead to a higher cost of borrowing.”

Industrial companies have been doing more than most to try and reduce pension deficits over the past couple of years. Last year, those in the FTSE350 used an average 40% of free cash flow to pay down the shortfall – the second-highest average payment in the corporate sector. Energy companies paid an average of 68% of their free cash flow in deficit contributions last year – a 20% increase compared to a year earlier.

Across the FTSE350, shortfall contributions have become 30% more expensive than the payments made for future pension benefits, Barnett Waddingham said.

Per member, companies in the FTSE350 are paying £2,600 a year for future benefits, and £3,400 to clear the backlog accrued in the deficit.

In 2010, 16% of companies operating a defined benefit pension paid more than 100% of free cash flow to try and plug the funding gap – in 2011, 28% of them contributed this much.

The report said: “The worsening of these figures can be attributed to both an increase in funding deficits for the majority of companies and an increase in the number of companies where free cash flow is now negative. For many companies contributions have changed significantly between 2010 and 2011.”

Yesterday, the Pension Protection Fund revealed that there were 5,248 schemes in deficit at the end of September, and 1,184 fully funded or in surplus in the UK.