IF YOU READ NOTHING ELSE, READ THIS…
- Most employers with DB schemes expect a negative impact on the business’s financial performance
- M&A activity and the ability to raise finance are being stifled by DB deficits.
- Auto-enrolment is expected to add to employers’ cost burden.
An employer’s pension scheme, particularly if it offers defined benefits (DB) and is in deficit, can have a huge impact on the way a business operates. So how do pensions affect a business? Broadly speaking, there are five main areas on which a plan can impact:
1. Cashflow
DB schemes continue to be a cash drain on employers, restricting their ability to use working capital to grow the business. Nick Salter, senior partner at Barnett Waddingham, says: “DB schemes are risking making [employers] uncompetitive. They are worried about the fluctuating cash demands and impacts of DB schemes on their accounts and this might impact their decisions to invest in long-term projects to grow their business.”
2. Solvency and the ability to raise finance
A DB scheme represents a significant risk for the employer and it is a risk managed by trustees who may not share the employer’s risk management objectives. This can weaken the balance sheet, limiting the organisation’s ability to raise further capital.
A significant amount of corporate debt will need to be refinanced in the next few years,” says Salter. “I would expect banks to be paying particular attention to DB pension schemes when negotiating the terms.”
John Cockerton, senior consultant at Towers Watson, adds: “Many sponsors are now seeking a long-term journey plan that will lead to a solution of their pensions issues, often by transferring the liabilities to an insurer or by reshaping member benefits.”
3. Takeovers, mergers and acquisitions
Pension funds have long shaped takeover, merger and acquisition (M&A) activity. There was a time when a pension surplus would make an employer a valuable target for a takeover. However, Danny Cox, head of advice at Hargreaves Lansdown, says: “Pension scheme deficits can become a major hurdle to a takeover or buyout and a significant cost to put right.”
Complex pensions legislation giving trustees significant powers to influence M&A transactions can further damage M&A activity. Oliver Rowland, senior consultant at Towers Watson, says: “The impact of DB pensions continues to restrict M&A activity in the UK, with many purchasers refusing to take on a business that sponsors DB liabilities.”
4. Global competitiveness
UK businesses face significant pension costs, particularly where there is a deficit to be plugged. In a globally competitive market, these costs can put UK businesses at a significant disadvantage, damaging growth and wealth creation prospects for the country. For many UK businesses, pension costs are likely to rise further with auto-enrolment, which Salter describes as: “the biggest change to private pension provision in decades”.
5. Workforce management
The trend towards defined contribution (DC) pensions in the UK will result in some staff having insufficient retirement savings, says Rowland. This will not only tarnish the pension brand, but can seriously hamper an employer’s ability to manage its workforce, he says.
Salter is also concerned about employers that close their DB schemes to new members and introduce less generous DC schemes instead. He argues that, although there may be good financial reasons for doing this, it can create tensions between employees doing similar jobs, a situation employers will have to handle with care.
