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Pensions Deficits: Royal Dutch Shell alone has a shortfall of £73bn

Dividends at some of Britain’s largest companies – many of them likely to be a staple of your portfolio – could be at risk from ballooning pension deficits.

Huge final salary pension obligations have the potential to limit your investment returns, with tighter regulation and negative publicity surrounding the demise of BHS, the defunct retailer once owned by Sir Philip Green, already taking their toll.

Analysis by Telegraph Money shows that, of the 10 companies paying the highest dividends in Britain, seven have a pension deficit of more than £10bn, prompting concerns for the sustainability of payments to shareholders. Many of us will be investing in these companies through company pension schemes and other savings plans.

The deficit among FTSE 100 companies grew by £95bn in 2016 to £681bn, according to research released last week by pensions consultancy JLT Employee Benefits. Sixteen companies also reported a deficit of more than £10bn, while Royal Dutch Shell alone has a shortfall of £73bn.

Respected fund manager Alex Wright, who runs the Fidelity Special Situations fund, pays particular attention to companies with large pension deficits, describing them as an “albatross around the neck”.

While it is possible to argue that pension deficits are merely an accounting concept, they do pose risks. “They are definitely something to be aware of and are important,” said Laith Khalaf, an analyst at Hargreaves Lansdown, the fund shop.

“You have some companies with very big pension deficits and that is undoubtedly a risk. “That said, companies tend to have long-term funding plans with their trustees. I know interest rates aren’t going anywhere fast but the only direction is probably up, and that could help solve the problem, although people have been saying interest rates will go up for years and they have gone down or stayed the same.”

The deficits are the legacy of the expensive “final salary” pension schemes that were once popular but have now been all but phased out and replaced with “defined contribution” schemes in the private sector.

Between them, HSBC, Royal Dutch Shell, National Grid, British American Tobacco and Lloyds Banking Group accounted for 34pc of all dividends paid out in Britain in the second quarter of this year. Only one of those companies, British American Tobacco, has a pension deficit of less than £10bn.

Despite this bleak picture, independent pension consultant John Ralfe said there was little reason to be concerned. “If you are a FTSE 100 company then by definition you are one of the biggest companies in the country so you will have a high credit rating and be capable of issuing debt,” he said.

The real problem would come with smaller companies with less borrowing power, he added. A study by consultancy Barnett Waddingham, also released last week, into the deficit at FTSE 350 companies found that only 45 firms had increased dividends while reducing deficit contributions. This number has fallen from 79 in 2014 and 61 in 2015. This suggests that fewer are now giving priority to shareholders over pensioners.

Charles Cowling, a director at JLT, credited changes in behaviour on the part of firms with deficits to the actions of the regulator, but said the BHS scandal, in which Sir Philip Green’s company collapsed while it had a pension deficit of £571m, had also played a part.

“Every time something like that happens it affects behaviour in lots of different ways,” he said. “It makes companies more wary of buying and selling subsidiaries with pension schemes. If you are a buyer you need to undertake due diligence and if you are a seller you will be thinking ‘could that happen to me?’.”

He added: “The regulator is encouraging more deficit contributions, sometimes at the expense of dividends, and when that does happen it will hit share prices.”

However, he echoed Mr Ralfe in saying that shareholders should not be too concerned. JLT’s report also acknowledged that 41 FTSE 100 companies could wipe out their entire deficit with one year’s dividend payment, while 11 companies could clear their deficit with two years’ worth of payments.

“Investors should be aware of it and those companies with larger schemes need to take a much closer look at them,” Mr Cowling said. “But the share price should include all current information, including a deficit, so it’s not as if that information isn’t in the public domain.”

And there is one piece of accepted wisdom which certainly doesn’t seem to have changed – companies with the word British in their name tend to have a larger pension deficit. This is usually a hangover from their days as a nationalised entity.

“There’s quite a lot of truth in that anecdote and there is a good reason for it,” he said. “The reality is defined benefit pensions started in the public sector and they will finish there.

“It was the public sector which first created these generous schemes and when a lot of these companies were sold off they were sold with these large pension obligations.”

He said this factor remains even among companies which have since dropped the word British from the name. British Airways, for example, is now part of the International Airlines Group, although the brand still remains.

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