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Pension fund deficits - plse contribute

Practical discussions about equity High-Yield Portfolios (HYP) for income
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DYOR
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Pension fund deficits - plse contribute

#35375

Postby DYOR » March 1st, 2017, 12:10 pm

That is very helpful info on the pension deficit, thanks. I have recently been involved in the valuation of an unfunded pension liability and the actuaries insisted on using three scenarios for discount rates, the difference in the size of the deficit at the lowest rate was ten times that at the highest of the three rates! The pension in question was not in the UK so the rates are not comparable. But it does raise a question in my mind as to who determines these discount rates, the actuaries, professional body, pensions regulator? That decision could make a significant difference to the view on a number of HYP candidates, not just CLLN."

Terry.

Some questions on pension deficits came out of the Carilion thread above, but I thought perhaps it warrants its own topic?

Two recent sets of results announcements were Centrica and Carillion. Regarding their pension fund liabilities:

1. Centrica decreased its discount rate from 3.9 to 2.7%, increasing the pension liability from £100m to £1.1bn (rounded)
2. Carillion decreased its discount rate 3.95 to 2.7%, doubling the pension fund liability in the process

One notable difference is Carillion is making cash contributions into this pension fund liability, and it doesn't appear that Centrica is.

From what I could find, deciding when a company needs to make cash contributions is quite opaque:

"Notes on deficit measures: Funding: the target used by pension fund trustees to determine company cash contributions, calculated on a bespoke basis for each pension fund, agreed between the trustees and sponsor."

My profile doesn't have permission to post links to the internet yet. The above was sourced from an article by a PWC partner in Feb 2017

Whilst changes in the discount rate is relatively important, the decision whether cash contributions are required is more so IMHO as this might impact on dividend policy

Terry, appreciate this doesn't answer your question on who decides what discount rates are applied. Correlation between 1 and 2 above might suggest industry practice?

Look forward to some comments and contributions to this relevant topic please

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Re: Pension fund deficits - plse contribute

#35386

Postby Alaric » March 1st, 2017, 12:44 pm

DYOR wrote:Whilst changes in the discount rate is relatively important, the decision whether cash contributions are required is more so IMHO as this might impact on dividend policy


With a defined benefit scheme, the real costs are what the benefits are. Factors affecting these are longevity of the beneficiaries and the rules for determining benefits, these including the index used for inflation revaluation. The discount rate is really just a measuring rod, since if it's too high or too low relative to the investment return, the surplus or deficit stays within the influence of the Company and its pension fund. Put too much in though and it may become difficult to retrieve.

Pensions can be regarded as deferred pay, but the effects of tinkering with the rules and the inability of schemes to earn very much with guaranteed returns means that today's shareholders may still paying for employees who last worked twenty years ago. Really once someone has left employment, there should be enough money in the pension fund to cover their benefits without recourse to current shareholders.

Moderator Message:
Not sure what relevance this has to HYP Practical? Move to another board, unless anyone can let me know how this relates to HYP Practical. Raptor.

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Re: Pension fund deficits - plse contribute

#35464

Postby MrFahrenheit » March 1st, 2017, 3:48 pm

Not sure what relevance this has to HYP Practical? Move to another board, unless anyone can let me know how this relates to HYP Practical. Raptor.


Pension liabilites can wipe out a company's ability to pay dividends. For example (just off the top of my head)
- British Airways (not a HYP firm, but one I worked for) was for many years unable to pay any dividends at all, as the pension fund Trustees had first call on any profit it made.
- British Telecom had big issues with funding its pension obligations.
- Centrica (as per DYOR's post) got £1bn added to its liabilities just from a discount rate change.
- Carillion (as per DYOR's post) saw its liabilities double.

Since these things can make a big difference to future flows of dividends, even for big HYPworthy companies, I would suggest that they are relevant.

What we can do about them, I'm not so sure. Maybe the discount rate(s) used for pension liabilites could be used as some sort of safety factor? The reasoning being that a company that's already using a more conservative discount rate is less likely to have to change it and suffer an increase in liabilities.

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Re: Pension fund deficits - plse contribute

#35468

Postby Raptor » March 1st, 2017, 3:56 pm

So, what we are saying is how does these pension deficits affect whether we "pick" them for HYP shares. I seem to remember a thread on that before, but cannot locate it. Interesting thought.

In today's climate of low interest rates I would think many of our HYP companies will be looking at their Pension schemes very closely. However, I go for strategic ignorance.

Raptor.

DYOR
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Re: Pension fund deficits - plse contribute

#35482

Postby DYOR » March 1st, 2017, 4:36 pm

What we can do about them, I'm not so sure. Maybe the discount rate(s) used for pension liabilities could be used as some sort of safety factor? The reasoning being that a company that's already using a more conservative discount rate is less likely to have to change it and suffer an increase in liabilities.


I agree with this approach. To take an extreme pension deficit example, anyone considering adding BT to their HYP should probably take note that the liability of ~£5.2bn in the 2016 results was based on a 3.3% discount rate. Per "footnote a" in the cash flow statement, £880m cash was pumped into this liability during 2016. This compares with £1.1bn of cash outflows to dividends in the same period, as some sort of reference. Then make an assessment on the 3.3% discount rate.

The same approach can be followed for any potential investment, or even on existing investments.....

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Re: Pension fund deficits - plse contribute

#35483

Postby Alaric » March 1st, 2017, 4:41 pm

DYOR wrote:Then make an assessment on the 3.3% discount rate.


Equally ask whether the pension fund Trustees are making at least 3.3% on the money handed over. If they aren't, the pension fund will have an additional ongoing shortfall from the lack of investment earnings. That's in the absence of additional liabilities to the beneficiaries arising from longevity or excess inflation.

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Re: Pension fund deficits - plse contribute

#35511

Postby Wizard » March 1st, 2017, 6:10 pm

Yes, and understanding that it was a discount rate adjustment that resulted in the drop in Net Assets for a company (as was the case for Carrilion) may have an impact on a decision as to whether such a drop is a warning sign of trouble ahead or not.

One further question from me for th accounting experts. Am I right in thinking that such adjustments to pension liabilities are direct balance sheet adjustments, i.e. they do not go through the P&L? If they do go through P&L obviously they can distort other safety factors such as cover.

Terry

DYOR
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Re: Pension fund deficits - plse contribute

#35546

Postby DYOR » March 1st, 2017, 8:44 pm

Terry,

I'm looking at the 46 page prelim stock exchange announcement from Carillion's website. Note 8 (p.37) shows what was recognised in the p&l vs the balance sheet. In addition, p.24 (Consolidated statement of changes in equity) shows that the increased liability was taken directly against retained earnings. So in summary, yes, the knock was taken directly in the balance sheet.

Some interesting observations on cash and debt. I'll post that on that Carillion thread.

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Re: Pension fund deficits - plse contribute

#35857

Postby 77ss » March 3rd, 2017, 4:54 am

DYOR wrote:

Two recent sets of results announcements were Centrica and Carillion. Regarding their pension fund liabilities:

1. Centrica decreased its discount rate from 3.9 to 2.7%, increasing the pension liability from £100m to £1.1bn (rounded)
2. Carillion decreased its discount rate 3.95 to 2.7%, doubling the pension fund liability in the process

One notable difference is Carillion is making cash contributions into this pension fund liability, and it doesn't appear that Centrica is.


Not so. Centrica made a £77m contribution and, going forward:

The Group has now finalised its triennial review with the Pension Trustees, based on the position as at 31 March 2015, with an agreement to fund a £1,203m deficit on a Technical Provisions basis, with additional annual cash contributions of £76m per year over the next 14 years commencing in 2017

DYOR
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Re: Pension fund deficits - plse contribute

#35858

Postby DYOR » March 3rd, 2017, 6:05 am

The Group has now finalised its triennial review with the Pension Trustees, based on the position as at 31 March 2015, with an agreement to fund a £1,203m deficit on a Technical Provisions basis, with additional annual cash contributions of £76m per year over the next 14 years commencing in 2017


Well spotted, thank you 77's

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Re: Pension fund deficits - plse contribute

#35864

Postby Arborbridge » March 3rd, 2017, 7:41 am

1. Centrica decreased its discount rate from 3.9 to 2.7%, increasing the pension liability from £100m to £1.1bn (rounded)
2. Carillion decreased its discount rate 3.95 to 2.7%, doubling the pension fund liability in the process


But the government has just asked the insurance industry use a negative interest rate! There's no consistency in the policy, it seems to me - probably accounted for by different authorities applying slightly different arguments.
If the best they can do is a negative interest rate, someone should whisper HYP in their ears. I'd suggest any family who invests compensation money at a negative interest rate is bordering on negligent.*

*PS the problem is not finding a rate, of course, but the size of the compensation pot which needs to be invested weith complete security.

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Re: Pension fund deficits - plse contribute

#35870

Postby 77ss » March 3rd, 2017, 8:33 am

DYOR wrote:
The Group has now finalised its triennial review with the Pension Trustees, based on the position as at 31 March 2015, with an agreement to fund a £1,203m deficit on a Technical Provisions basis, with additional annual cash contributions of £76m per year over the next 14 years commencing in 2017


Well spotted, thank you 77's


The interesting point is that a £1.2bn deficit is being paid down at a mere £74m a year.

I assume that in any discussions between the company and the trustees, the possibility of an increase in the discount rate will figure large. Reclaiming pension fund surplus can be done, but better perhaps not to have one.

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Re: Pension fund deficits - plse contribute

#35986

Postby DYOR » March 3rd, 2017, 3:18 pm

The interesting point is that a £1.2bn deficit is being paid down at a mere £74m a year.


Yes, there are obvious inconsistencies between companies. For example, BT (as mentioned above) is contributing ~£880m to the deficit of £5.2bn (around 17%).

Not sure if these inconsistencies have a scientific basis or is just down to horse-trading with the trustees. One would hope the former...

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Re: Pension fund deficits - plse contribute

#36011

Postby Alaric » March 3rd, 2017, 4:33 pm

DYOR wrote:Not sure if these inconsistencies have a scientific basis or is just down to horse-trading with the trustees. One would hope the former...


More likely the latter. If the strength of the sponsoring organisation is not in question, a deficit could be just left to run with the point being that the organisation will always be able to pay benefits as they become due. That's in effect how many public sector schemes operate although many of them don't have any tangible assets at all, being solely reliant for funding on the future taxpayers picking up the bill. Centrica being in part at least a regulated utility might argue that it will always exist.

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Re: Pension fund deficits - plse contribute

#36012

Postby Breelander » March 3rd, 2017, 4:36 pm

DYOR wrote:
The interesting point is that a £1.2bn deficit is being paid down at a mere £74m a year.


Yes, there are obvious inconsistencies between companies. For example, BT (as mentioned above) is contributing ~£880m to the deficit of £5.2bn (around 17%).

Not sure if these inconsistencies have a scientific basis or is just down to horse-trading with the trustees. One would hope the former...


In the case of BT, it's a binding agreement negotiated with the Trustees in 2014 and with specified payments out to 2030 - 'horse-trading' or 'scientific' I'll leave for others to decide...

BT Pension Scheme wrote:What payments will BT make to address the deficit?
BT and the Trustee have put in place a recovery plan to address the deficit over 16 years. BT will pay £1.5bn by the end of April 2015 and a further £250m in each of the years to March 2016 and March 2017. From 2018 to 2024 BT will make payments in line with the 2011 agreement (being an average of £690m per annum). These will be followed by £495m per annum through to 2029 with a final payment of £289m in 2030.
http://www.btpensions.net/180/pension-funding-valuation

Bree. (holds BT.A)

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Re: Pension fund deficits - plse contribute

#36017

Postby Arborbridge » March 3rd, 2017, 4:54 pm

Not sure if these inconsistencies have a scientific basis or is just down to horse-trading with the trustees. One would hope the former...


I'm not sure why the former is better than the latter - I would expect it to be both. "Science" has a limited approach when dealing with unknowns, in my view, and the end result must be a compromise. For example, in extremis, a perfect solution for the trustees and the regulator might bankrupt the company, which wouldn't do anyone any good!

So, for pensioners, employees and a shareholders, I would hope it's a numbers backed horse trade which leads to the best kind of deal: that is, one where all parties are averagely happy with the outcome.


Arb.

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Re: Pension fund deficits - plse contribute

#36029

Postby DYOR » March 3rd, 2017, 5:49 pm

In the case of BT, it's a binding agreement negotiated with the Trustees in 2014 and with specified payments out to 2030


It begs the question for me, in the event that a pension liability increases due to a lower discount being applied, whether this triggers another round of negotiations with the trustees around required cash contributions. Probably not one to keep you awake at night, unless the divi already looks at risk

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Re: Pension fund deficits - plse contribute

#36038

Postby Arborbridge » March 3rd, 2017, 6:14 pm

DYOR, the answer to your question - unless there is some sort of crisis - is that the review will normally be carried out once every three years. I can tell you from personal experience, that seems to come round quite fast enough!
I believe BT's triennial may be due this year and despite pumping in huge amounts of cash, I expect it will look worse than last time.

This is one reason I would find it unfair to split off Openreach, the cash generator, and leave the rest of the company carrying an large burden of responsibility. I dare say, there's a big area for horse trading there.

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Re: Pension fund deficits - plse contribute

#36074

Postby 77ss » March 3rd, 2017, 8:28 pm

DYOR wrote:
The interesting point is that a £1.2bn deficit is being paid down at a mere £74m a year.


Yes, there are obvious inconsistencies between companies. For example, BT (as mentioned above) is contributing ~£880m to the deficit of £5.2bn (around 17%).

Not sure if these inconsistencies have a scientific basis or is just down to horse-trading with the trustees. One would hope the former...


A bit of both, I suspect. I think BT may be a bit of an outlier, for historical reasons.

One also needs to put deficits in context. Obvious, I know, but worth emphasising.

A deficit of £663m for a company with a market capitalisation of £929m is one thing (CLLN).
A deficit of £1,137m for a company with a market capitalisation of £12,470m is quite another (Centrica).

Market capitalisation may not be the best comparator, but it illustrates the point.

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Re: Pension fund deficits - plse contribute

#36082

Postby DYOR » March 3rd, 2017, 9:52 pm

I believe BT's triennial may be due this year and despite pumping in huge amounts of cash, I expect it will look worse than last time.


I did some digging and found the following from the Hargreaves Lansdown website, dated January 2017

"BT is aiming to grow the dividend by at least 10% this year and next, and the shares currently offer a prospective yield of 5.6% in FY 2017/18. However, net debt and the pension deficit both stand at over £9.5bn. With more cash likely to be needed to plug the pension shortfall after a review of the funding position later this year, pressure on free cash flow is only likely to increase."

So you are quite right on timing

On Openreach, I found the following on the BBC (dated Nov 2016). Not sure if there is anything more up to date?

"Ofcom has come some of the way, with Openreach now to become a legally separate entity, with its own independent board. But crucially it will still be owned by BT. Telecoms experts say the devil will be in the detail - how much control will BT be able to exert over Openreach under the new structure?
Sky and Talk Talk will be watching for any signs of too much influence - but if BT has no say at all over Openreach, it may in the end decide to break itself up anyway."

Probably going a bit off topic here though


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