UK company dividends are under threat from the developing crisis of runaway pension scheme liabilities, according to Redington.
The consultant’s warning comes as data from the Pension Protection Fund (PPF) 7800 index revealed the aggregate deficit for the UK’s 5,954 defined benefit (DB) schemes increased from £376.8bn at the end of July to £459.4bn at the end of August – a funding ratio drop from 79.2% to 76.1%.
The increase was primarily driven by the Bank of England’s decision earlier in the month to slash interest rates to 0.25% and increase its quantitative easing (QE) programme by £70bn.
Redington head of DB Dan Mikulskis said the latest PPF figures “painted a grim picture” for many pension funds, particularly those with low liability hedge ratios.
He said: “The primary driver has been gilt yields falling by around 30 basis points over the month of August, as the Bank of England cut interest rates and announced further QE amid a deteriorating picture for growth. The yield fall has increased the liabilities, and widened the aggregate deficit.”
Mikulskis (pictured) added increasing liabilities and the subsequent DB “black holes” may lead to UK firms cutting or cancelling dividends. He alluded to plastics manufacturer, Carclo, which slashed its dividend earlier this month because of its spiralling pension deficits.
He said: “For schemes that have not hedged, this will be a blow to balance sheets and it may lead to more UK companies warning over dividends, especially those that are carrying out an actuarial valuation and agreeing a new recovery plan, (which is likely to come with significantly higher contributions) during the second half of 2016. The current pensions landscape has emphasised how important managing pension risk is to the health of a scheme sponsor.”
Elsewhere, Aviva Investors investment strategist, global investment solutions, Boris Mikhailov said the PPF’s data reinforced the need for schemes to have a “robust and adequate” hedging strategy in place.
“The full extent of this short position will be acutely felt by many pension schemes come their tri-annual actuarial valuations later in September,” he said. “By taking disproportionately large short position in interest rates it also dwarfs the impact of any other investment decision pension a scheme makes, however good these decisions might be.”
Blackrock head of UK strategic clients Andy Tunningley said as well as cutting dividends, companies could struggle to make up the pensions shortfall by increasing scheme contributions at a time when UK growth is likely to be challenged.
He added: “In reality, the onus is likely to be ever more on the funds themselves to manage the risk appropriately – for instance, through defensible allocations to hedging assets – and to find pockets of opportunity, such as the illiquidity premia available through well sourced private market assets.”