ECONOMIC OUTLOOK | Pensions
SPOTLIGHT ON EUROPE THE PENSION RISK
There continues to be challenges for overseas sponsors with UK defined benefit (DB) pension schemes: challenges compounded by the imminent prospect of Brexit. Andrew Vaughan, a partner at Barnett Waddingham, highlights the risks faced and how they are managed by European companies with UK pension obligations IMAGE SHUTTERSTOCK
A
particular feature for European corporates is the scale of UK pension liabilities. Barnett Waddingham’s
review into 75 constituent companies listed on share indices in France, Germany, Italy, the Netherlands, Spain and Scandinavia shows that they were committed to UK pension obligations of more than £100 billion up to 31 December 2015. On average, UK schemes accounted for 28% of these companies’ global liabilities related to DB pensions. Furthermore, UK pension contributions represented around 32% of global DB contributions on average. However, the average proportion of global revenue produced by the UK subsidiaries of these firms was just 7%. (see chart overleaf). European parents with UK subsidiaries
are potentially exposed to significantly greater pensions risk than the scale of their operations in the UK would suggest. The companies in our survey were also
paying considerably more per head – in 2015, the average UK pension contribution per UK employee was over three times greater than the equivalent average for the global parent. This may reflect cultural differences –
for example, non-UK businesses may operate in countries where state pensions are comparatively more generous than in the UK. Also, DB pensions are more
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prevalent in the UK than in most other European countries. Alternatively, it may reflect differences in local scheme funding regulations. Nonetheless, it highlights the materiality of pension liabilities for overseas corporates with UK subsidiaries.
EUROPEAN COMPANIES CONTRIBUTE MORE THAN THE FTSE350 In 2015, the average funding level of the schemes surveyed on an accounting basis was marginally higher than over the equivalent period for FTSE350 companies. Interestingly, DB pension contributions as a proportion of staff costs were higher than those in the FTSE350. The average deficit contribution per employee was also higher than those in the FTSE350 for companies surveyed – the implication of this being a faster return to full funding relative to UK-listed firms. Between 2014 and 2015, DB contributions by UK subsidiaries increased by around 6%.
INVESTMENT RISKS In most cases, the total level of equity holdings held in the UK scheme(s) was substantial relative to the UK firm’s net assets. There were a small minority of
‘ If interest rates remain at relatively low levels for longer, this will be unwelcome for unmatched schemes’
cases where the equity allocation exceeded the net assets of the UK subsidiary sponsor company. Exposure to equity markets via scheme investments represents a latent risk for sponsors. Although the UK subsidiary might be
able to rely on generous support from the European parent, the exposure to equity risk for some firms is noteworthy. While schemes may reduce their equity holdings such that assets are aligned more closely with scheme liabilities, this could lead to a significant increase in the expected cost of providing benefits under the scheme.
THE IMPACT OF BREXIT
As outlined above, the existing risks to European sponsors of UK schemes are significant. With Article 50 to be triggered in March 2017, these risks could change (with potentially a positive impact as well as negative) following Britain’s negotiation for a deal over their terms of exit from the European Union. One potential area is the UK funding
regime. If the government decides to offer more flexibilities to DB sponsors following on from February’s Green Paper – that is, to pay much less attention to deficits and more enthusiasm in providing benefits in full as they fall due; however, this could be extremely disruptive and outside the European legislations. Some commentators have lobbied for the DB regulatory regime to move in a more liberal direction. There might even be a R
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