Reducing DB deficits costs FTSE350 37p in every £1

Our annual FTSE350 research has shown that firms pay 37p out of every £1 they spend on pension provision on reducing existing defined benefit (DB) pension deficits.

Despite the research’s finding that FTSE350 firms’ pension deficit contributions are now at the lowest level they have been for 5 years, they still equate to almost 40% of the total paid towards pension provision for the UK’s largest businesses.

The research, conducted for the fourth year running, highlights the impact DB – or final salary – pension schemes are having on FTSE350 businesses.

This year’s research also found that DB schemes are having a significant impact on shareholder returns with deficit contributions of 33p being paid for every £1 paid out to shareholders in dividends. However, this is also at the lowest level it has been for 5 years (when compared to an average of 38p over the preceding 4 year period).

Key findings from the research include:

• The total IAS19* deficit reported by FTSE350 companies in 2013 was £55.6bn representing a £7.6bn reduction in the aggregate shortfall from the previous year.
• Deficit contributions paid in 2013 were £8.5bn, representing a decrease of over 20% compared with the preceding year.
• The effects of auto-enrolment on the bottom line became apparent, with an average increase of 16% in defined contribution (DC) cost for the largest firms in the FTSE350.
• Deficit contributions exceeded free cash flow for nearly one quarter (23.6%) of the companies in our study.
• There were 37 companies who could have afforded to buy-out their DB scheme using the increase in their cash holdings from 2012 to 2013
• Over 40% of companies in each of the Consumer Staples, Consumer Discretionary, and Utilities sectors are paying more in deficit contributions that they are towards future pension provision for their employees.

“The fact that 37p of every pound spent by companies on pensions is paid towards clearing pension deficits is striking and illustrates just how much companies are still having to pay in order to reduce funding shortfalls. This 37p, along with the significant amounts that have been paid historically, is being diverted to pay for pensions for the generation of employees lucky enough to receive a DB pension. The lack of pensions saving by subsequent generations will be further addressed through auto-enrolment but the difference in the quantum of contributions being paid, which will ultimately determine the level of pension, is huge.

“Nonetheless, the overall picture for DB funding in 2013 has improved somewhat with deficit contributions seemingly placing less of a strain on company finances particularly for some of the more extreme cases we saw several years ago. With TPR’s new funding Code of Practice promising to be less restrictive on corporates going forward, directors should be optimistic about the future. Our research already notes an improvement in the scale of deficit contributions being ploughed into DB schemes and there has been a welcome reduction in deficit contributions relative to dividends paid to shareholders.

“Shareholders, which will include DC pension savers, will also welcome the increase in dividend payments relative to DB scheme deficit contributions which must have been a major drag on shareholder returns.

“The FTSE350 still had 180 companies offering some of their current employees access to a DB pension at the time of reporting their 2013 financials. With the end of contracting-out for DB schemes on the horizon and with the Pensions Minister’s crusade to introduce a legal framework that will allow companies to offer some form of 'risk sharing' pension arrangement, it will be interesting to see how pensions or perhaps more accurately in future 'retirement savings' will change over the next few years.”