Jeremy Warner: Thanks Dave. That’s just what investors needed

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The Independent Online

Outlook To believe the way they are reported in published company accounts, there is no problem with pension fund deficits right now. Some of them are obviously whoppers, but across the piste, defined benefit pension schemes look to be marginally in surplus. Unfortunately, this is just a trick of the accounting light.

Accounting standards require funds to be benchmarked against double A rated corporate bonds, where spreads have widened hugely over the last couple of years to unprecedented levels. This has had the perverse effect of dramatically decreasing the notional cost of pension liabilities when they are discounted back to present-day values.

Regrettably, the picture these conventions present is a far cry from the truth. The reality is that defined benefit schemes are facing a quadruple whammy of fast rising liabilities (due to enhanced life expectancy), reduced asset values, slumping income (because of lower interest rates and slashed dividends), and financially weakened sponsoring employers.

On any realistic view, pension deficits are already off the scale and rising fast. One estimate puts the combined deficit of funded UK defined benefit schemes at £200bn. For companies struggling with slumping demand and scarce credit, some of these deficits may have become life-threatening. As if things were not already bad enough, here comes the pensions regulator, David Norgrove, with his hobnail boots to warn companies that addressing the pensions problem cannot be swept under the carpet and left until trading conditions and profits improve.

The pension fund ranks equally with other unsecured creditors, he reminds employers, and if it comes down to a choice between paying the dividend and funding a pension fund, then sorry, but it is the dividend that must go. This is of course as unfortunate for the financial health of pension funds as it is for equity markets, for many schemes are still substantially invested in shares and rely heavily on them to fund their liabilities. It may be something of a zero-sum game to be slashing dividends to prop up pension funds.

Ultimately, the best guarantee of security for a pension scheme is to have a financially strong and viable sponsoring company. If plans previously agreed with the regulator and trustees to repair pension deficits (recovery plans) begin to threaten that viability, something has to give. Bankers who see companies with big pension fund commitments are going to be more wary still of providing ongoing credit.

To be fair on Mr Norgrove, he is prepared to cut companies some slack and is calling on trustees to do the same. In some cases, he may allow recovery plans to be suspended. Marc Hommel, UK pensions partner at PricewaterhouseCoopers, points out there are lots of ways for companies to reduce their cash commitments to pension schemes, at least temporarily, without damaging security.

These include profit-related funding and back-end loading of contributions when conditions permit. The important thing is for companies to enter a dialogue with trustees and regulators early before the problem arises. Yet it is a dime to a dollar pension fund commitments will prompt a string of insolvencies before the recession is out, and then where will the members be?

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