Why Are Companies Rejecting Buyouts (Even When They Can Afford It)?

Companies have the cash, so why are they not derisking their pension funds? Maybe there is too much else going on.

(August 16, 2012) — Companies listed in the United Kingdom are channelling an average 12.5% of cash generated by core activities each year to plug funding gaps in their pension funds, despite many having the money to de-risk.

Over the past three years, deficit contributions to defined benefit (DB) pension funds have consumed four and a half months’ worth of cash generated by the largest 350 listed companies in the UK, consultants and actuaries Barnett Waddingham said this week. This equated to the cash generated by core activities for one and a half months each year being spent to try and close the pension funding gap.

These extra payments were made despite almost a quarter having enough cash holdings at the end of 2011 to de-risk their pension fund through a buyout structure, Barnett Waddingham said.

“Despite the significant level of contributions, DB scheme deficits remain a concerning issue,” said Nick Griggs, head of corporate consulting at Barnett Waddingham. “Many companies continue to take a longer term view on the funding and investment strategy for their DB scheme. This is evidenced by the investment risk being taken and the number of companies that have increased their cash holdings to a level which might allow them to realistically consider a full scheme buy-out, which so far they have chosen not to do.”

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Barnett Waddingham found that 24 of these 350 companies could have afforded a buyout solution with the cash generated in 2011 alone.

Companies and their pension boards may have been distracted by market movements that appear alien to many. Barnett Waddingham said for 80% of companies, changes in real yields had become a greater source of volatility than equity market movements.

Equities have seen a relatively calm period over the last couple of months, despite on-going market turmoil. The index monitoring equity market volatility – the VIX – hit five year lows this week after pushing up a little at the end of May. These numbers have been markedly down on the same period last year when the VIX spent weeks at record high levels.

Year-to-date, the MSCI World Index is up 7.97%, and has displayed a relatively smooth trajectory, save a blip at the end of May.

Conversely, real yields have been on the move – in a downwards fashion – more than many corporations would like. The drop has also hit pensions twice as liabilities and portfolio returns have both been impacted.

Steve Collins, head of dealing at boutique fund manager London & Capital, said: “In the UK, due to the powerful combination of quantitative easing and low nominal GDP growth, real yields, remarkably, are now negative for maturities up to 20 years.”

It is against these yields that actuaries need to discount existing liabilities.  

Collins concluded: “The move to negative real yields has created a lot of volatility in the calculation of these liabilities, effectively saying the value of future pay-outs is higher than the value today – This is quite a problem for pension schemes, and it isn’t going away for some time to come.”

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