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What economic recovery means for your scheme

By Pippa Stephens 09 April 2013 |

“Simon Kew, our Director of Pensions, sounds a note of caution at the start of the UK’s economic recovery, noting that increased interest rates could have a detrimental effect on some employers.”

 

A recovery for the UK’s beleaguered economy is obviously considered a good thing.

But it could bring difficult times for UK pension schemes, say insolvency practitioners, if rising interest rates push up refinancing costs for weaker employers, edging them towards the brink.

Last week, the British Chambers of Commerce’s quarterly survey reported a boost in confidence in the UK economy, powered by rising exports and domestic sales in the first quarter of 2013.

Another survey of 300 companies by Lloyds Bank found greater confidence about the
economy in March than at the start of the year. These results have gone some way to calm
concerns the economy is heading for its third recession in five years.

Before the crisis, interest rates were bobbing along at around 5 per cent, but were cut to 0.5 per cent three years ago in an attempt to stimulate lending following the global recession. The Bank of England has kept the rate at this lower level.

Recovery could change the Bank’s approach, dragging so-called ‘zombie companies’ – only kept alive by the recession’s low interest rates – into insolvency, and dumping their schemes into the Pension Protection Fund, say practitioners.

If growth in the economy allows companies to grow, pension schemes may find company money being used to employ more people or an expansion of company infrastructure, and away from the scheme, according to funding experts.

Spotting an economic recovery

Schemes are often reminded to test the strength of their employer covenant. But there may be merit in keeping one step ahead and looking out for signposts in the economic recovery, managing insolvency risk, or simply watching out for good news to tell members.

“A very rapid rise in the cost of debt is going to be a problem for companies who are inherently indebted,” says Jonathan Smith, head of UK strategy at Schroders.

“The thing schemes should be looking out for is inflation. If inflation rises very quickly, that is going to be painful for many people.”

While a higher level of inflation in a recovering economy could be “bad news” for schemes, a stronger return in equities could offset it, he adds.

Inflation is currently at 2.8 per cent. The BoE’s Monetary Policy Committee is expected to control inflation through adjusting interest rates, to bring inflation back to its 2 per cent target. “We would expect, if growth returns, the Bank of
England isn’t going to hold interest rates at half a per cent forever, it is going to raise them to help put a lid on inflation,” says Smith.

The other side of growth

Simon Kew, head of pensions at insolvency practitioners Jackal Advisory, says: “As the economy gets healthier, there will be less pressure on interest rates. Those rates will start to rise and those companies who are just about keeping their head above water, hopefully, will start to see some upturn in profits and turnover.”

But the upturn in profits and turnover would usually come after the rates bump, meaning some companies could have a pension scheme liability that dwarfs their turnover, triggering an insolvency process, Kew adds.

Schemes face a struggle against other creditors in such cases. Giles Orton, chairman at Bridge Trustees, says trustees are always in a weaker position than banks in the event of an insolvency.

“Companies tend to be more concerned about keeping their banks happy than keeping their trustees happy,” he adds. A slew of bankruptcies would mean more schemes ending up in the PPF, which could then feed through to increased costs for unaffected schemes.

“We remain vigilant to all changes in the economic environment but we are in this for the long term so do not necessarily have to react to short-term changes to the risks we face,” says a spokesperson for the organisation.

“But we have always said that if our risk continues to remain high or does increase, we may have to raise the levy we charge all eligible schemes.”

Concerned trustees should assess the health of the employer at each trustee meeting, how it has traded over the previous period and what the forecasts are, asking for the employer’s input where appropriate, says Kew.

“Having a bit of a reality check and looking at the ‘well, what if’, and trying to prepare themselves as best they can, will help,” he adds.

Schemes could talk to their employers to get forecasts and any available management information. Kew says: “Open and honest dialogue is always the mantra.”

The plus side of growth

An improved economy may allow companies to grow, which could also have unintended consequences for schemes.

Orton says: “It is not lack of profit, it is lack of cash that usually kills companies and often in times of rapid economic growth this can put pressures on cash flows – not necessarily by a rise in interest rates, but by businesses expanding quickly.

“When your business gets bigger, you actually soak up cash. It’s a nice problem to have, [but] it is a risk in terms of rapid expansion.”

The scheme may find itself competing with the company’s growth as, for example, the company requires upfront money for rising numbers of staff and equipment to expand.

There may be a lag time between these outgoings and a later profit, meaning a temporary dent to the company’s cash flow, Orton adds. Schemes may wish to take these factors into account in planning for an economic recovery.

By intelligently considering how a recovery could affect the employer covenant and the cash available to the scheme, and by maintaining an open dialogue with employers, schemes can be one step ahead of future business risks.

Category : Savants in the News — admin @ 12:00 am April 9, 2013