Pension fund deficits: A hole new ball game for workers
By Rod Newing
Published: June 22 2009 01:16 | Last updated: June 22 2009 01:16
Independent pension trustees are becoming vigorous in defence of their members when the restructuring cake is cut.
“A defined benefits pension scheme is a large, unpredictable, aggressive and powerful creditor that makes solvent turnround much harder,” says Jon Moulton, managing partner at Alchemy Partners, a turnround private equity firm. “It dominates the early stages of assessing a turnround and it may even stop it. If you sell assets to pay down debt, you will have the trustees round your ears.”
According to the Pensions Protection Fund, only 953 of the 7,400 defined benefit funds in the UK were in surplus this April, with the rest having a total deficit of £204.8bn ($334.5bn). Pensions schemes are being squeezed in two ways, with investments falling in value while the cost of pension provision continues to rise sharply. According to the Pensions Protection Fund, total assets fell 9.8 per cent over the year while liabilities rose 15.8 per cent.
“The [total deficit] could increase to £689bn by the end of 2009, equivalent to nearly 40 per cent of the country’s gross domestic product,” warns Rob Hunt, director and senior actuary at Xafinity Corporate Solutions, a pension provider. “Even if the FTSE 100 recovered to 5,000, the combined UK pension scheme deficit would still be around £583bn.”
Towers Perrin, the professional services company, is equally gloomy. It has found that the FTSE 100 companies’ pension deficits of £44bn in May will take more than 20 years to pay back at current contribution rates.
Employer contributions to reduce deficits on this scale have a fundamental impact on the financial performance of the business and can even cause its insolvency. They starve the business of the cash it needs to reduce the cost of servicing its borrowing or to provide much needed investment.
“The days when pension liabilities could largely be ignored in restructuring work are very much in the past,” says Hywel Robinson, a partner at Clifford Chance, lawyers.
Close Brothers Corporate Finance comes up against pension deficits in about one in five restructuring deals. “The scheme can be bigger than the company itself,” says Christopher Clayton, the company’s managing director. “Companies usually need turning round because of trading issues, not pension deficits, so it is not necessarily the main issue.”
In any turnround there is usually fierce competition for available cash or assets that can act as security. Patrick Bloomfield, a partner at Hymans Robertson, a firm of consultants and actuaries, says pension schemes are no longer a due-diligence afterthought but are at the heart of negotiations. They are a common obstacle in debt for equity restructurings, as they rank behind secured debt, but in front of equity.
“Where secured debt is being swapped for equity, it will be very important to avoid the situation where post-restructuring profits are used to plug pension deficits, rather than flowing through as value to equity,” he says.
On the other hand, the trustees of the pension fund will want to act quickly to ensure that the fund maximises the contributions it receives. This involves balancing the risk of long-term contributions that are dependent on future trading, with short-term needs that could push the business into insolvency.
The trustees may want contributions to eliminate the deficit in 10 years, yet 15 years may be lower risk if it gives the business the funds that it needs to improve its trading.
Mr Clayton says that 20-25 years is not uncommon, but once the company is more successful the trustees will want more money to go into the scheme.
Mr Moulton points out that in many cases, if the company cannot make a full contribution to a scheme, it could pay a quarter or a half.
“It is in the interests of the trustees to keep the company going so that it can make some contribution,” he says. “At the moment there is a very great temptation to put the company into bankruptcy.”
Gary Squires, head of pensions at Zolfo Cooper, a restructuring specialist, says trustees are increasingly influential in financial restructuring. “We are seeing deals which legitimately address pensioners’ interests but avoid employer failure,” he concludes. “This preserves value and ensures that as many jobs as possible are saved in difficult situations.”
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Trustees: Experience and professionalism are key to successful negotiations
Dealing with pension fund trustees in a turnround is becoming a big issue, especially if the fund is in deficit. Traditionally, trustees were directors or employees of the company, with conflicting interests, so there has been a growing trend to appoint independent paid trustees, bringing much-needed expertise to the table during complex negotiations.
“Banks and bondholders will want to see business plans and cashflow forecasts to assess whether to continue supporting a business through a restructuring,” says Lisa Ashe, director at AlixPartners, a turnround consultancy.
“Trustees will want the same information to understand the likelihood that the employer will be able to fully fund the pension scheme over a given period. Based on their assessment of the financial resources of the employer, the trustees will try to negotiate the largest cash contributions that they believe the employer can afford.”
Christopher Clayton, managing director at Close Brothers Corporate Finance, warns that unlike banks and bondholders, trustees are not in a position to inject new funds, so tend to be last in the pecking order. He welcomes the involvement of independent trustees. “In a turnround, you need an experienced and professional trustee,” he says, “so you can have a proper and sensible negotiation”.
Janette Rutterford, professor of financial management at the Open University Business School, points out that many more recent employees are not in a defined benefit scheme and must not be treated unfairly compared with their longer-serving colleagues in the scheme. In some circumstances it may be best for the trustees to push the business into insolvency.
“It takes nerves of steel to start on a course of action that will lead to losing your own job [most trustees in the UK are also employees],” says Anne-Marie Winton, a pensions partners at Nabarro, the law firm. “Beneficiaries also include former employees and pensioners, so saving jobs may in fact not be a priority for trustees.”
She points out that the level of financial and commercial sophistication demanded of non-professional trustees is currently at an all-time high. On a group restructuring, trustees may end up negotiating highly-technical security documentation, such as charges over property assets or inter-company guarantees, or reviewing 100-page financial covenant reports.
According to a recent survey by Pinsent Masons, the law firm, 83 per cent of trustees are now independently advised, compared to 10 per cent 10 years ago.
“The trouble is that the advisers are converted actuaries who are thoroughly content to give you a 10-year view on the prospects of the company,” says Jon Moulton, managing partner at Alchemy Partners, a turnround private equity firm. “They would have starved to death if they had been equity analysts.”
Sometimes new faces are needed at the table, especially if trustees feel that they have been misled or lied to by company management over an extended period of time. In those circumstances, the trustees may resist restructuring proposals from the incumbent management.
“New management can offer increased credibility,” says David Falzani, a director of the Sainsbury Management Fellows Society. “They can drive home to the trustees the implications on the deficit and the interests of the employees if the turnround does not come about. That can lead to a reasonable trade-off between the employer’s responsibilities and the need to build a viable business.”
Every scheme has different rules and every country has its own pension legislation. This means that there is no blueprint or template for dealing with trustees and little in the way of best practice.
“In a restructuring, there is no simple answer and no ‘plain vanilla’ solution,” concludes Mr Clayton. “There is a range of options and each one has to be looked at carefully. It is absolutely critical that anybody involved in restructuring, particularly someone putting new money into the business, understands the powers of the trustees.”
Copyright The Financial Times Limited 2009
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