Dividends in danger as pension deficits soar
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Even before the UK’s decision to leave the EU, defined benefit (DB) pensions schemes were under strain. People are living longer, the ratio of pensioners to contributing members is rising and most schemes simply do not have enough funds to meet their obligations.
However, the Brexit vote has exacerbated matters resulting in the shortfall between assets and liabilities in DB schemes increasing dramatically. The yield offered by government bonds has collapsed, sharply increasing the cost on paper of financing future retirement benefits.
In addition, DB schemes have been hit by the Bank of England’s (BoE) own monetary policies designed to keep the economy on track. The BoE has cut interest rates form their historic low of 0.5% to 0.25% and announced £70 billion quantitative easing and £60 billion of gilts purchases.
Whilst company shares that pay regular or growing dividends have become attractive to income investors over the past few years as bond yields have already been low, there is now a prospect of pension scheme deficits threatening those dividends too.
As pension scheme deficits worsen, attention has moved towards dividends that are being paid out by companies. The actuarial consultants, Lane Clark & Peacock, detail in their annual ‘Accounting for Pensions report’ (a copy of which can be downloaded here) that the combined pension deficit of the 56 companies in the FTSE 100 that disclosed a deficit at their 2015 year-end was £42.3 billion. Those same companies paid dividends totalling £53 billion, some 25% higher. If such companies can afford to pay out dividends that are more than the pension scheme deficits, then the argument is that they should be tackling their pension deficits.
We expect therefore that as a result of growing pension deficits, companies will be forced to re-evaluate the level of dividend pay-outs to shareholders. Likewise, we are likely to see more companies looking to close their DB pension schemes to future accrual in an attempt to curb pension liabilities, as we have seen recently with Marks & Spencer who are embarking on a closure exercise.
