Plug pension fund deficits with cheap debt
Euromoney, is part of the Delinian Group, Delinian Limited, 4 Bouverie Street, London, EC4Y 8AX, Registered in England & Wales, Company number 00954730
Copyright © Delinian Limited and its affiliated companies 2024
Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement
Sponsored Content

Plug pension fund deficits with cheap debt

UK corporates that use cheap debt to fill the gaps in their pension funds could enjoy significant strategic, cash flow and accounting benefits. James Courtenay-Evans, Managing Director, and Shoaib Yaqub, Associate Director, Corporate Financing Solutions at RBS, explain.

Ballooning pension liabilities on the back of low bond yields have led to a big increase in pension deficits and a step change in annual sponsor contributions, which have settled after almost doubling since 2008.

But the low bond yields have also created a unique opportunity to fund deficits faster with debt raised at attractive terms.

While all companies will need to consider their own tax circumstances, for a profitable company, the cash flow benefits of this include crystallisation of the tax shield and therefore a tax deduction earlier – which will be more advantageous as UK corporate tax rates continue to fall.

Using cheap debt also helps companies reduce their overall cost of capital. And it arguably leads to some equity risk – implicit in the pension deficit – being diversified.

Companies need to think about this now. Doing nothing could lead to more strain on their balance sheets and the cheaper debt available might then be out of their reach.

Other benefits of using cheap debt to fund pension deficits are:

  • New accounting rules mean that the impact of upfront funding on earnings per share will be positive in most cases

  • Using debt funding that matches the pension cash contribution tenor – typically five to 10 years – rather than the length of the pension liability may result in a funding cost arbitrage

  • Terming-out the material ongoing cash contributions by a one-off debt funding may lead to medium-term cash flow gains

  • Rating agencies could see it in a positive light

Changes to the IAS 19 accounting standard made effective this January mean the impact of a company’s pension fund on its profit and loss (P&L) accounts is more akin to paying interest. This removes any advantages of aggressive asset allocation for sponsors and will hit the P&L for companies with higher deficits harder.

It therefore pays for corporates to focus much more closely on pension deficits. There are various ways they can fund them, such as cash contributions or granting charges over assets. Despite the benefits, some businesses have been reluctant to use debt because it involves tying in debt capacity against a long-term liability that may disappear over time.

But strong debt market conditions – at least for now – are making such a move more attractive.

There are benefits, as well as some drawbacks, whatever happens to interest rates in future.

If rates remain the same, companies will see a cash flow benefit in the medium term and will have addressed an ongoing pension funding gap – allowing them to concentrate on their core business.

They will have strong balance sheets and be more profitable thanks to cheap debt driving a lower cost of capital.

One downside is that they will not be able to borrow as much for investment, although this will be less of an issue for stronger corporates with plenty of debt capacity, particularly following a sustained period of deleveraging corporate balance sheets.

If we enter a higher interest rate environment, companies with debt-funded pensions may have cheap, long-term debt locked in, reducing any future cash constraints through potential contribution holidays. The flip side is that they will have no recourse to the pension surplus but there are structures that can address that.

If interest rates fall even further, corporates will still have improved balance sheets and enjoy greater profitability. A nd in a difficult macroeconomic environment with low growth, proactively addressing the pension deficit might be seen as positive by employees, shareholders and customers.

Whatever happens, there is a strong case for injecting debt-backed cash into the pension pot now. It’s no wonder that more and more businesses are considering it very carefully.


No representation, warranty, or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained in this document and no member of the RBSG roup accepts any obligation to any recipient to update or correct any information contained herein. The information in this document is published for information purposes only and does not constitute an analysis of all potentially material issues. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation. You should take independent advice in respect of issues that are of concern to you.

This document does not constitute an offer to buy or sell any investment, and nor does it constitute an offer to provide any products or services that is capable of acceptance to form a contract. The products and services described in this document may be provided by any member of the RBS Group, subject to signing appropriate contractual documentation. No member of RBS shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this communication.

In the UK the Royal Bank of S cotland plc is authorised by the P rudential Regulation A uthority and regulated by the Financial C onduct A uthority and the Prudential Regulation A uthority, in Hong Kong by the Hong Kong Monetary A uthority, in S ingapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation A uthority A BN 30 101 464 528 (AFSL icence No. 241114) and in the US, by the New York S tate Banking Department and the Federal Reserve Board. The financial instruments described in this document are made in compliance with an applicable exemption from the registration requirements of the United S tates S ecurities A ct of 1933, as amended. I n the United S tates, securities activities are undertaken by RBS Securities I nc., which is a FINRA/SIPC ( member and subsidiary of The Royal Bank of S cotland G roup plc. Dubai I nternational Financial C entre: This material has been prepared by The Royal Bank of S cotland plc and is directed at “Professional C lients” as defined by the Dubai Financial S ervices A uthority (DFSA ). No other person should act upon it. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Professional C lient”. This document has not been reviewed or approved by the DFSA . Qatar Financial C entre: This material has been prepared by The Royal Bank of S cotland N.V. and is directed solely at persons who are not “Retail C ustomer” as defined by the Qatar Financial C entre Regulatory A uthority. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Business C ustomer” or “Market Counterparty”.

The Royal Bank of S cotland plc. Registered in S cotland No. 90312. Registered O ffice: 36 S t A ndrew S quare, E dinburgh E H2 2YB. The Royal Bank of Scotland N.V is authorised by De Nederlansche Bank (DNB) and is regulated by the A utoriteit Financiele Markten (AFM) for the conduct of business in the Netherlands. The Royal Bank of S cotland plc is in certain jurisdictions an authorised agent of The Royal Bank of S cotland N.V. and The Royal Bank of S cotland N.V. is in certain jurisdictions an authorised agent of The Royal Bank of S cotland plc.

Copyright 2013 RBS. A ll rights reserved. This communication is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any purpose without RBS’s prior express consent.

Gift this article