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UK firms to enjoy cash boost from pension changes

Source: Reuters - Tue 27th Jul 2010

The government said this month it would bring private defined-benefit pensions in line with public sector equivalents, for which annual increases will from next year be linked to the consumer prices index (CPI), instead of the retail prices index (RPI), which is the current legal minimum.

CPI excludes housing costs such as mortgage interest and is typically lower than RPI. Since 1988, CPI has on average run at 2.8 percent, against RPI of 3.6 percent, and for the next five years could be 1 to 1.5 percent lower than RPI, analysts say.

Analysts said the proposed changes could particularly help companies with big pension deficits, such as British Airways, BAE Systems, Lloyds Banking Group, Royal Bank of Scotland and National Grid, some of which have deficits of more than 4 billion pounds.

Since pension liabilities are calculated by reference to expected future payments, a cut in the indexing rate would have an immediate impact on the size of the deficits and the contributions needed to fund the schemes.

"We would suggest that this change may result in improved cashflow for companies, which would be positive for either funding growth, or improved shareholder returns through dividend or share buybacks" said Gerard Lane, equity strategist at Shore Capital.

According to a survey by consultancy firm KPMG, around 80 percent of pension schemes could be affected by the proposed rule changes. It estimates that the changes could reduce private sector pension deficits by around 45 billion pounds.

Some pension schemes may opt out of the proposed changes on the grounds that their rules and bye-laws do not permit them to move to CPI, but KPMG says that if the changes are applied on all private-sector pension schemes, the deficit reduction would be more than 100 billion pounds.

"It's going to take some pressure off - one less obstacle for companies to contend with in a very difficult operating environment" said Mike Lenhoff, chief strategist at Brewin Dolphin.

"From the point of view of the companies, it's significant. It's a reduction in cost for them so long as RPI remains above CPI. It allows them a little bit more flexibility as to what they can do with the contribution that they would otherwise have had to make."

Some estimates show that a pension deficit of 1.3 billion pounds by a company could turn into a surplus of 900 million pounds after switching to the CPI measure of inflation.

British Airways said last month it had agreed a recovery plan for its 3.7 billion pound pension deficit. It said the move would avoid the closure of the schemes and maintain its annual contributions at the current level of 330 million pounds.

"Every company will do whatever it can to reduce their pension liabilities as much as they can. We agree that it will certainly free up cash flow for the corporate sector" said Peter Dixon, economist at Commerzbank, referring to the proposal of linking pension hikes to CPI.

According to watchdog Pension Protection Fund, a total of 4,420 defined-benefit schemes of 6,653 were in deficit, and the aggregate deficit stood at 21.8 billion pounds at the end of June. Total assets were 901.5 billion pounds, while total liabilities amounted to 923.3 billion.


Analysts said the proposed changes were a welcome move for the pension industry and were expected to underpin UK share prices.

"The accounting standards have forced pension liabilities onto the balance sheet, and that causes problems. Rising life expectancy has also caused problems for the companies" said Laith Khalaf, pensions analyst at Hargreaves Lansdown.

"So if you have your liabilities wiped off your pension scheme, the funds that you have to put towards plugging that deficit can be used elsewhere" he added.

Some analysts were cautious in predicting the impact of the proposed changes to link to CPI on British companies.

"Primarily, the actual size of pension deficits in many cases is such that this change will not stop the need to think in terms of refunding measures" said Howard Wheeldon, senior strategist at BGC Partners.

"This change only goes some way to slowing down the year-to-year impact on pension deficits - it does not cure the problem that we have been too lax and complacent over the past 20 years, or that allowing companies to take pension holidays back in the eighties was an absolute mistake."

tthe size of the deficits and the contributions needed to fund the schemes.

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