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Triple whammy exacerbates pension deficits

Super-low government bond yields, falling assets prices and rising mortality rates are exacerbating the pension deficits of UK and European companies, with new accounting changes next year expected to further hit the corporate sector hard.

In a report on Monday, Morgan Stanley European equity strategists, led by Krupa Patel, argued these three factors have largely provoked the recent sharp rise in corporate pension liabilities, to record levels for UK companies in particular. 

Some 84% of £267 billion in defined pension plan schemes in the UK were reported to be in deficit in June, with companies such as embattled travel company Thomas Cook, Premier Foods, electrical retailer Dixons and defence contractor BAE Systems among those running the biggest pension liabilities, according to Morgan Stanley. 

Thomas Cook, which has been struggling under punitive levels of bank debt, had the highest percentage of net pension liabilities ($516 million equivalent) in the UK compared to its market capitalization ($236 million) at 218.8%, the report said. Premier Foods had the second highest (161.7%), followed by Dixons in third (45.5%). 

In Europe, French telecommunications equipment supplier Alcatel-Lucent (139.3%), Dutch insurance group Delta Lloyd (120.9%) and German steel company Salzgitter (107.8%), had the highest percentage of net pension liabilities versus market cap. 

Morgan Stanley’s Patel wrote: “First, monetary-easing programmes undertaken by various central banks across Europe since 2008 have led to falling government bond yields, which raise the present value of company liabilities. Second, mortality rates have been on the rise and latest figures released by the Office for National Statistics show a significant increase in life expectancy rates in the UK. Third, a lack of recovery in the equity, bond and commercial property markets has added to the ongoing pension problems of corporates in Europe.”

One impact of this has been on the pension funds’ allocation to the equity markets. 

According to Morgan Stanley, UK pension funds’ equity allocation has fallen to its lowest level since 1974, and in the euro area, insurance and pension funds’ equity holdings have declined to a 13-year low. It added that within equities, funds have shifted their allocations away from domestic exposure, with the average weight of domestic equities in global pension portfolios having fallen 17 percentage points since 1998. 

The Morgan Stanley report also warned that forthcoming IAS-19 pension accounting changes could have a detrimental impact on corporate earnings. 

Patel wrote: “Under the new IAS-19 accounting rules, effective from January 1, 2013, companies will be barred from using the corridor approach, which allowed them to keep losses related to pension schemes off their balance sheets. Additionally, the long-term expected rate of return on pension assets will need to be assumed to be in line with the discount rate.” 

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