Pensions Bill unlikely to aid firms with big liabilities

While most coverage of the Pensions Bill to be announced in the Queen's Speech on Wednesday will focus on the concept of a nationwide Collective Defined Contribution (CDC) pension scheme, equity investors should be looking at what the government plans to do about allowing employers to whittle down the benefits provided by their existing final salary pension schemes.

The corporate world has hoped that for future accruals into workplace final salary schemes, employers would be allowed to remove the costly inflation protection which is obligatory on pensions in payment, and revalued annually according to inflation measured either by the retail prices index (RPI) or consumer prices index (CPI) or 2.5% if higher.

In addition, final salary schemes may be released from obligation in their Trust Deeds & Rules to provide additional benefits such as dependents' pensions to widows, widowers and children, and they might also be allowed to automatically raise pension ages if their staff live longer. Members who have left their employer before retirement could lose even more rights.

Some form of weakening in employers' obligations seemed a slam dunk a few months ago, with strong support from pensions minister Steve Webb, but current thinking is less sure this is the path the government will want to tread.

One drawback is its potential impact on index-linked government bonds, which have fallen whenever the idea has been mooted, because pension funds would not have to purchase as much inflation protection. Moreover, while scrapping the inflation link could slash firms' bills by as much as £7 billion, according to independent consultants Mercer, that would make for a lot of unhappy pensioners - at least 2 million in fact - in the run up to the next election.

The discussion about changing final salary pension terms came about as part of the consultation into a mid-way between defined contribution and defined benefit pensions, which has produced the initiative for a Dutch-style CDC scheme.

However, it thought that, after the new encashment freedoms announced for defined contribution pensions in the last Budget, the odds are now so thoroughly stacked against final salary schemes that there is no incentive for employers to keep them open to future accrual. Only on Monday Marstons announced it will close its final salary scheme to future accrual from September 2014.

Largest pension deficits

Some of the largest UK pension deficits belong to household names. The Lloyds scheme, for example, has assets of £32.6 billion, but a deficit of £998 million, and announced earlier this year it hopes to save a precisely equivalent sum by freezing employee benefits.

And large as they already are, pension deficits continue to snowball. For example, Barclays deficit was £1.8 billion by February 2014, compared with £800 million in 2012.

At least five companies have been found by a 2013 Lane, Clark & Peacock survey to have liabilities greater than their equity market value - BT, BAE Systems, International Airlines Group, Royal Bank of Scotland and RSA.

To add to their woes, a further problem has been meted out in the last week, that only the most nerdy pensions people know about. The Pension Protection Fund has been working on the levy formula paid by final salary schemes to fund the bailout scheme, for the years 2015/16 to 2017/18.

As well as raising the cash levy by around £50 million per firm, it proposes toughening the conditions for certifying a Type A contingent asset, where a parent company gives a weaker subsidiary a guarantee, and only including the value of certified asset backed contributions where the underlying asset is UK property. This could mean some companies would have to bridge multi-million holes in their pension accounts.

It could hit companies such as British American Tobacco, Legal & General, Rio Tinto and Standard Life, which have company guarantees in place for some of their pension liabilities, and Centrica, and InterContinental Hotels, which have given their schemes a charge over certain assets.