Pension deficits deter PE

The pension problem affecting many UK companies is continuing to hit the private equity industry, with new research showing that two thirds of private equity firms have abandoned deals because of pension liabilities.

The report by Punter Southall Transaction Services, entitled The Market Value of Pension Liabilities, found that all those surveyed had encountered some sort of pension problem with target companies, with 88% frequently coming across such difficulties.

It revealed that over 90% of private equity professionals price pensions obligations of companies with defined benefit schemes at FRS17 or stronger, with around 20% saying they priced on the basis of the full cost of securing the benefits promised with an insurance company which is significantly in excess of the FRS17 shortfall.

Paul Geeson, principal at Punter Southall Transaction Services, said: “Given private equity professionals do not believe the UK equity market prices on an FRS17 basis, unlike the UK private equity or debt markets which do, quite clearly an FRS17 deficit acts as a significant barrier to a takeover from a private equity firm, even before we consider the attitude of the Pensions Regulator towards leveraged transactions.”

A senior adviser to Punter Southall, David Willetts MP, proposed a new system to reduce pension liabilities in a speech he gave in mid-October. He argued in favour of a government-sponsored scheme whereby employers could pay the government to take contracted-out liabilities back into the state scheme.

Willetts said: “”If the total size of the pension fund promise is reduced, that in itself could prove a great help in creating the condition for what is surely on its way – namely a secondary market in company pension promises. Anything that brings liabilities down to a manageable size increases the chance of the rest being manageable and marketable. Then companies would really be able to transform their balance sheets by taking promises off them. We are in danger of having zombie companies struggling to pay their pension costs, incapable of expanding and too toxic to be taken over. This is bad for British business and bad for the British economy.”

He rejects criticism that the idea is an “unacceptable socialisation of costs borne by companies”, arguing that if the calculation is made on fair basis, there is no direct subsidy. “I would love to believe that British company deficits were going to cure themselves through slow improvements in equity markets,” he says. “It is possible that will happen but it is unwise to plan on that basis. Britain is unique in having almost no safety valves to help with deficits in place. The only exception is the ability of the PPF to cut the value of pension benefits if they wish. Therefore I believe we need to look much more radically at ways in which company pension deficits are reduced.”