Jeremy Warner's Outlook: Those pension fund deficits keep on rising, but are they as dangerous as they seem?

EasyJet prepares for Icelandic invasion
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The Independent Online

Another day, another scare story on the burgeoning size of Britain's pension fund deficits. The latest alarm is sounded in an obscurely titled paper posted on the actuarial profession's Pensions Board website, which suggests that the true size of the deficits may have been hugely underestimated.

Should equity investors sit up and take note, or is much of the debate that surrounds occupational pension scheme deficits just alarmist exaggeration? The fact that the UK stock market barely moved yesterday in response to the headlines may suggest more of the latter than the former, or at least that the worst may already have been factored into stock prices.

The first thing to note is that worrying though these deficits are, they are not of themselves life threatening in the majority of cases. Calculated on a FRS 17 basis, they amount to little more than 5 per cent of the total market capitalisation of the FTSE 100. This is not a figure to be taken lightly, but it is dwarfed by other corporate liabilities, such as bank debts, and even if it were two or three times that amount, it wouldn't cause wholesale corporate collapse.

In some cases, of course, the pension problem is much more acute - British Airways and Rolls-Royce immediately spring to mind. Yet it didn't prevent Rolls-Royce from being one of the best performers in the FTSE 100 last year. The stock market judges other factors, such as trading prospects, to be more important. In any case, the better a company's prospects, the more capable it becomes of addressing the deficit.

The Pensions Board paper deals with the so called "buyout" value of pension liabilities, or the amount it would cost in today's money to pay for all promised pensions in full. This is always going to be a much larger figure than the FRS 17 deficit which most companies use for accounting purposes, but it is only really relevant if a company is winding up, and therefore is unable to provide an ongoing operation to support the pension scheme.

According to the paper, many pension funds may be seriously underestimating their pension liabilities, either by using an inappropriate discount rate or because they have failed to take account of greater longevity. If pension funds were to use the assumptions applied by life offices in bulk annuity deals - that is when they buy a job lot of annuities from a pension fund - the size of their liabilities would look bigger by an order of magnitude. According to one estimate, the FTSE 100 deficit might be as high as £150bn on this basis, or three times projections for the FRS 17 deficit.

This has always struck me as one of the most powerful reasons for thinking the insurance industry can never be relied upon to provide a wholesale solution to the pension deficit problem. Most finance directors would give their eye teeth to get shot of their occupational pension fund liabilities by paying an insurance company to take them off their hands.

Yet if the amounts demanded by the insurer are greater than the estimated wind-up costs of the fund, then it's not going to look an attractive way out. The insurer is bound to take an extraordinarily conservative view in exposing his shareholders to such uncertain future liabilities, and he will want to make his profit on top.

It is of course right that shareholders should have as much information about a company's pension liabilities as there is to give. We live in an ever more transparent world, and if companies are hiding the true extent of their pension deficits by using inappropriate mortality or discount rates, then investors need to know. Yet to treat these liabilities as tantamount to a debt, as the pensions regulator, David Norgrove, has suggested, is misguided and dangerous.

A pension fund deficit, however it is defined, is only a point in time snapshot of the shortfall between current assets and future liabilities. In two important respects, it is quite unlike other forms of debt, for it is neither fixed in size nor is it redeemable in the foreseeable future.

Pension liabilities are extremely long term in nature, and the company's ability to fund them depends on a number of unknowns - future cash flow, asset values, interest rates, inflation, longevity, and so on.

To force companies to recognise and report on their pension deficits is one thing; to force them into precipitous action to close them - by for instance forgoing dividend payments or cutting back on investment in the business - is in most cases inappropriate and unnecessary. It may make older workers feel a little more secure, but it will be at the expense of competitiveness and the long-term future of the business. Older workers benefit at the expense of younger ones.

I'm not saying that pension deficits are things best left ignored, as some kind of mirage that time will dissolve away. Yet the fashion for thinking of them as current liabilities is destructive and misplaced. Some commentators are in any case almost certainly exaggerating the size of the problem and its likely impact.

Higher corporate contributions are tax deductible, so the taxpayer will end up funding a fair proportion of them. Furthermore, many companies are using the alarm stirred up by the media exposure as a bargaining tool with employees - as a way of sharing the burden by persuading pension fund members to accept higher contributions, lower benefits, or both.

For corporate Britain, these deficits are not as big a threat as they are made out to be, or rather, they needn't be if the regulator doesn't interfere. Undoubtedly they have been a factor in the underperformance of the UK stock market in recent years, but last year's 17 per cent gain in the index suggests strongly that the worst of the effect is past, despite ever more alarmist projections of the size of the liabilities.

EasyJet prepares for Icelandic invasion

With a dominant shareholder sitting on 40 per cent of the company and reportedly not interested in selling out for less than £5 a share, why would easyJet need to bother about retaining the services of Goldman Sachs to defend itself against FL Group, the owner of Icelandair?

At that price, the no-frills airline would surely be too rich even for Jon Asgeir Johannesson, the man who has mopped up seemingly half the UK's high street, and his fellow directors at FL. FL already owns 16 per cent of easyJet, but if it were to pay £5 a share it would still need to raise £1.7bn to buy the rest.

For most people, Stelios Haji-Ioannou is still the personification of easyJet, yet these days the company has many other shareholders and any offer above the current price, inflated as it is by bid speculation, would have to be looked at seriously. In any case, the new chief executive, Andy Harrison, has only just eased himself into the pilot's seat and could hardly be expected to go down without a fight.

After the turbulence of easyJet's double profits warning in 2004, the airline has regained its composure and the shares are again gaining altitude. The bloodbath in the no-frills sector promised by Michael O'Leary, chief executive of Ryanair, has never really materialised. But it proved enough to deter a host of wannabes from entering the market with suicidal prices, enabling the two dominant low-cost carriers to re-inforce their position.

Perversely, high oil prices have also helped - by enabling Ryanair and easyJet to raise their fares under the cover of the fuel surcharges imposed by British Airways and other full-service airlines.

Not so long ago all the talk was of Stelios buying back the airline he founded and then floated in 2000. Now, he is again saying that he is a long-term seller of the stock. Not that he is desperate for the money. His other "easy" ventures aren't crying out for large infusions of cash at present, and the $90m he made last year from selling out of his original Greek shipping venture, Stelmar, went straight into the building society.

But is easyJet really worth as much as he thinks and do the Icelanders, for all their ambition and mysterious ability to raise money, have the bottle for a bid this big? We shall see.

j.warner@independent.co.uk

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