DB pensions threat to corporate profitability

Defined benefit (DB) pension deficits at the UK’s largest 350 listed companies have increased by over £2 billion since the start of 2016, according to a survey from Mercer.

The rise in deficits has been driven by falling yields on high-quality corporate bonds, which are used for the discount rate for pension costs. By August, the yield on a key corporate bond index was at 1.89%, down from 3.68% at the end of 2015. Mercer said that the rising cost of DB pension now represents around 40% of employee pay. Mercer UK head of pension accounting, Warren Singer, said: “Our analysis of current low bond yields shows that new DB pension savings now typically have an accounting cost about four times higher than the cost of defined contribution (DC) retirement savings. The impact of over £2 billion on profits is material compared with pre-tax profits of FTSE 350 companies of £84 billion in 2015.”

Singer added that Brexit had increased the uncertainty over company prospects, saying: “The key question is whether you expect 30 years of stagnation in the UK, as implied by the UK bond market. We have seen in Japan this scenario is possible but the Governor of the Bank of England has stated that UK bond yields are distorted by an investor community as a whole that is taking out insurance for extreme risk events. He believes there will be adjustment and growth without question. However, if employers believe in a low growth world, they may find it unsustainable to allow employees to continue building up new DB pension savings.”