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Royal Dutch Shell one of the companies with biggest pensions deficit

After Carillion how many firms can the pensions lifeboat rescue? 

The Pension Protection Fund can absorb the firm’s liabilities but the spotlight is now on others with big pension deficits

The companies with the biggest deficits, according to a report last year from pension consultants LCP, are Royal Dutch Shell, BP, BT and BAE Systems. The four FTSE 100 companies each had a deficit of more than £6bn in 2016.

The sprawling construction and outsourcing firm had a pension deficit of £580m but is now likely to rise to at least £800m because it no longer has a solvent business standing alongside it. The company’s crash into liquidation has thrown the spotlight on other firms with huge pension scheme deficits such as IAG, BTand BAE.

It has also raised questions about how many more big company failures the Pension Protection Fund (PPF) can absorb, and why companies with big deficits are allowed to pump out bumper dividend payouts to shareholders.

It is almost certain that the fund will now have to step in and bail out workers at Carillion, which has more than 28,000 defined-benefit – in this case, final salary – pension scheme members. Those already taking pensions will be protected, but those members below retirement age will face cuts of 10-20% because there is a cap on payouts to higher earners.

It’s been a busy time for the PPF: in the spring, roughly 20,000 members of the British Steel pension scheme will start moving into the fund. They will eventually be joined by about 2,000 former BHS workers (the vast majority of the retailer’s staff chose to move their retirement funds into a new pension scheme).

Carillion’s liquidation has fuelled concern about the financial stability of other big companies. Last year a report by JLT Employee Benefits put the total deficit in FTSE 100 pension schemes at the end of 2016 at £87bn – £17bn worse than a year earlier, even though firms paid in around £11bn. Sixty-six companies had deficits – ie their liabilities to pension scheme members were greater than their assets.

Booming stock markets in 2017 helped narrow the gap. Mercer, the leading pensions consultancy, said deficits at the biggest 350 firms fell to £76bn from £84bn the year before. But even with the FTSE at a new peak, the deficits remain alarmingly high.

Deficits have swollen because companies have to calculate their future pension liabilities using safe assets, such as gilts (government bonds). About 62% of pension investments are now in bonds, compared with 34% a decade ago. With interest rates at record lows, these bonds are growing very slowly in value – leaving the schemes with yawning black holes. Controversially, some firms are using more optimistic calculations that deflate their deficits.

According to JLT: “There are a significant number of FTSE 100 companies where the pension scheme represents a material risk to the business.” At the time of its report last summer 10 FTSE firms had deficits greater than their stock market value. The most dramatic deficit was at IAG, the parent of British Airways, which has led to the British national carrier being described as a pension fund with an airline attached to it.

Q&A: What is a pensions deficit?

The companies with the biggest deficits, according to a report last year from pension consultants LCP, are Royal Dutch Shell, BP, BT and BAE Systems. The four FTSE 100 companies each had a deficit of more than £6bn in 2016.

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However, perhaps LCP’s most damning finding was that FTSE 100 companies paid out four times as much in dividends in 2016 as they handed over in contributions to their defined-benefit schemes.

According to JLT, 41 FTSE 100 firms could settle their pension deficits in full with the cash paid out as dividends to shareholders in a single year. A further 11 companies would need a payment of up to two years’ dividends to eradicate their deficits while 14 companies would need a payment of more than two years’ dividends.

Carillion certainly seems to have put its shareholders first: in its most recent annual report, the firm boasted it had increased the dividend every year since the firm was established in 1999, and was “well-positioned to continue funding the dividend”.

Most firms have responded to pension pressures by shutting defined-benefit schemes to new employees and, increasingly, to refusing future contributions from existing members as well. Firms have also had little choice but to shovel more money into their schemes.

Last autumn, BA said it was shutting its New Airways Pension Scheme, which covers 17,000 staff. BA said it had paid £3.5bn into the scheme since 2003, pledged to pay a further £750m into the scheme and still had a deficit of nearly £4bn.

It is not just final salary schemes that have been axed. Tesco shut down its defined-benefit scheme too – which was based on career average earnings rather than final salary – to save cash after its pensions deficit soared above £3bn.

Quick guide: Britain’s six worst pension deficits in 2016

Royal Mail also closed down its 90,000 member final salary scheme on the basis that it was unaffordable – even though the scheme is one of the few in surplus thanks to the government underwriting pre-2012 pensions when the business was floated. The company decided it had to go, however, because it would run into deficit this year, even though Royal Mail pays in £400m a year.

The top five pension scheme deficits among FTSE 100 firms are said by LCP to be: Royal Dutch Shell at £6.92bn; BP with £6.72bn; BT Group’s £6.38bn; BAE Systems with £6.08bn; and Tesco’s deficit of £3.17bn.

The former pensions minister Steve Webb told the Guardian that “Carillion would be the biggest-ever hit on the PPF” but that the lifeboat would be able to “comfortably absorb” the Carillion scheme.

Nigel Green, the chief executive of deVere Group, one of Britain’s biggest independent financial adviser firms, said: “UK final salary pension schemes have an enormous deficit black hole, which raises the inevitable question: how many more big hits can the PPF take?”

The Carillion liquidation, he said, “should trigger alarm bells for pension savers across the UK”.

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