Opinion: companies must curb shareholder dividends to plug their pension deficits

It’s time companies prioritised workers’ pensions rather than income for shareholders to avoid another BHS-style debacle and it looks like The Pensions Regulator could make it happen.

The Pensions Regulator (TPR) has warned it will take a tougher stance on firms that prioritise shareholder dividends over reducing their pension deficits.

It follows the collapse of BHS in April last year, which left 11,000 people without a job and a £571 million pensions blackhole threatening the income of 22,000 members.

Although Sir Philip Green has agreed to pay £363 million to help plug the gap, the debacle highlighted how vulnerable some schemes could be to buckling under huge pensions deficits.

To avert a crisis, the Government is considering options like changing the way pensions are uprated each year, which would give firms a £90 billion boost but mean a £20,000 blow to some pension incomes.

But a better solution would be to prioritise workers’ pensions over paying shareholders dividends, and it’s something that The Pensions Regulator could be given more powers to enforce.

In its Annual Funding Statement the regulator sent out a reminder that firms had a legal obligation to workers’ pensions not shareholders’ dividends and those without a sufficient recovery plan would be investigated.

It warned: “Where we believe there is sufficient affordability to increase contributions to the scheme, we will take steps to ensure that an appropriate balance is struck between the interests of the scheme and shareholders by the employer.”

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The pension deficit problem

 In the UK, there are two types of pension schemes; defined benefit (DB) and defined contribution (DC).

DC schemes involve workers and their employer paying into a pot, and whatever sum they end up with can be cashed in or used to buy an annuity.

DB schemes are more generous and involve employers promising to pay an income for life, usually based on a worker's final salary­.

It's DB schemes that are the key cause for concern. The Pension Protection Fund – which pays compensation to members in failed schemes ­– estimates that the DB funding deficit stood at £226.5 billion at the end of April 2017 and there are currently 4,391 schemes in deficit but just 1,403 schemes in surplus.

Rising life expectancy, along with record low returns on investments, mean pension scheme trustees have been struggling to provide the steady long-term returns needed to cover future payout liabilities.

But aside from this struggle, it’s apparent that some companies have been more concerned with throwing money at shareholders than considering their responsibilities to their staff’s pensions.

Dividends could plug the gap

Analysis from consultants Lane, Clark & Peacock (LCP) on the latest 2015/16 annual accounts of FTSE 100 companies found they paid around five times as much in dividends as they did in contributions to their defined benefit pension schemes.

A collective £71.8 billion was paid to shareholders compared to £13.3 billion in pension scheme contributions.

In total, 56 FTSE 100 companies declared pension deficits amounting to £42.3 billion, but those same companies paid dividends totalling £53 billion – enough to clear the shortfall in one year. 

For 29 firms, the dividends were more than double what was paid into the pension fund.

So, in theory, these companies have enough to plug the gap in their pension schemes were they to divert more funds from shareholders and into their ailing pension schemes.

The BHS case

Paying out a sizeable dividend is often considered a show of a firm’s health. It can signal that management teams running a company are confident, which in turn could encourage investors to buy more stock and bump up the share price.

But in the case of BHS, the high street retailer that collapsed last year leaving a £571 million pension blackhole, it was the multimillion pound dividends paid out that have been blamed for weakening the retailer’s chance of survival.

The Work and Pensions Commons Select Committee report into BHS revealed that the total dividends paid by BHS Ltd were £414 million between 2002 and 2004, almost double the after-tax profits of £208 million.

A pension scheme being in deficit doesn’t necessarily mean it’s in danger and members won’t receive their money.

However, pension deficits can be a drain on companies and impact their ability to both invest and borrow money. As a result it can be particularly difficult for them to consider potentially valuable mergers and acquisitions.

While BHS did not pay a dividend in the years where it wasn’t making a profit, the act has been condemned as effectively removing value from the company and preventing the cash injections for investment or towards pension contributions that might have turned things around.

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Firms in trouble

Worryingly, BHS’s £571 million pensions shortfall is small scale compared to other firms like BT, Tesco and BAE Systems.

BT’s pension scheme, which has 300,000 members, reportedly has a deficit that has ballooned to £9.5 billion. It paid £880 million towards plugging the shortfall but £1.1 billion to shareholders in 2015/16.

But rather than managing expectations and changing the pace, BT is promising shareholders even better income over the next couple of years.

The firm’s annual report states: "Our confidence in future cash flow generation means that we expect to grow the dividend per share by at least 10% for each of the next two years."

Pension Protection Fund is a last resort

As more and more firms fail to meet their pension obligations it will be up to the Pension Protection Fund to step in.

However, the safety net can’t look after everyone and should only be a last resort.

Its own assets are currently at £23 billion. What's more retirement income isn't matched for everyone. For those under retirement age when a firm goes bust pensions benefits are capped at 90%, with an overall cap of £33,678 a year.

We need to act now

The Pensions Regulator could be handed more powers by the Government to force firms to take action to cut dividends in order to plug the gaps in their deficits.

But management teams should act now to show investors that sorting out their pensions liabilities is a better sign of strength than paying out dividends.

In 2015/16, just six FTSE 100 companies paid more in contributions to their pension schemes than in distributing dividends according to LCP analysis.

The need to replenish underfunded pensions may impact investors income in the short term, but the long-term benefits for workers have to take priority.

Take control of your pension with a SIPP

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