Pensions, accounting and quantitative easing tend to be rather dry subjects.
But, if you put the three together, as Citi has in a research note, you get something quite interesting.
Here’s the basic premise…
UK companies usually calculate their pensions liabilities using a discount rate based on high-quality corporate bond yields. These yields have increased in 2008, as you can see from the chart below, resulting in a somewhat superficial accounting boost to companies’ pensions schemes, discussed in full here.
Meanwhile pension trustees tend to err on the more pessimistic side — using gilt yields as a starting point for determing discount rates.
And there’s the rub.
With the Bank of England now QEasing by buying medium-long term gilts, gilt yields will drop further, resulting in much larger pension obligations.
Here’s Citi’s Kenneth Lee and Deborah Taylor on the effect:
Accounting guidelines require balance sheet pension obligations to be discounted using corporate bond yields, rather than gilt yields.
Nonetheless, quantitative easing is expected to reduce both yields and spreads on corporate bonds. Looking over the next 3-6 months, companies may therefore be using significantly lower discount rates for calculating balance sheet values than those used to report December 08 values. This could result in larger pension obligations, and therefore larger pension deficit values (or smaller surpluses) in company balance sheets.
There are a couple of caveats here.
Firstly as Citi notes, this is likely to be a short-term development. In the longer-term QE should help asset values recover enough to offset increased pensions liabilities. So the companies most impacted by QE will be those embarking on, or about to embark on, big revaluations of their pensions obligations — those include British Airways, Carillion, Trinity Mirror, Man Group and BT — all triennial revaluations.
But, we should also note, just because a company suddenly sees a larger pension deficit, doesn’t automatically mean it will go bust or some such.
In the UK, The Pensions Regulator is relatively flexible on the issue given the economic situation. From a February 18th statement:
There is no reason why a pension scheme deficit should push an otherwise viable employer into insolvency. But the pension scheme recovery plan should not suffer, for example, in order to enable companies to continue paying dividends to shareholders.
Any employer who believes that an existing recovery plan is at serious risk of jeopardising the company’s future health or solvency should discuss this with their pension scheme trustees, and we would encourage schemes and sponsors to talk to us if they have concerns.
In any case, here’s Citi’s list fo FTSE companies with the biggest pensions obligations.
Related links:
Accounting and pensions, when ‘twain meet – FT Alphaville