According to figures from pension consulting firm Aon Consulting, deficits within the pension schemes of UK companies have reduced by a huge margin, from over £40 billion ($119 billion; €89 billion) in May 2006 to less than £10 billion at the end of April this year. This could lead to complacency as buyers ?private equity buyers included ?assume that the problem has been largely dealt with. Perhaps with this in mind, the UK's Pensions Regulator has acted to stamp out any complacency.
The Regulator recently issued advice that pension scheme trustees in target companies are entitled to request payments from buyers in excess of any deficit that exists when accounting standard FRS 17 is applied to the scheme ?and may even be justified in asking for payments when, according to FRS 17, the scheme is well funded.
Legal sources say the Regulator's advice implicitly brings into question the validity of FRS 17 as a method of measuring the size of any deficit. ?The problem with FRS 17,? says Rosalind Connor, a pension specialist in the London office of law firm Jones Day, ?is that it makes a lot of market-based assumptions, and if the market changes the numbers can change dramatically.?
The volatility of FRS valuations was highlighted by Aon Consulting research which showed that, on February 27 this year ?a day on which turmoil originating in China affected markets around the world ?the value of UK pension deficits according to FRS 17 soared by £11 billion on just that single day. Critics say that this tendency of the FRS 17 valuation to fluctuate wildly over a short period makes it a less than reliable methodology.
Its validity was also brought into question in the recent failed attempt by a private equity consortium to buy Sainsbury's, the UK supermarket chain valued at around £10 billion. During the negotiations, the firm's pension deficit according to FRS 17 was valued at less than £500 million. But the trustees insisted on a £2 billion payment based on the cost of buying individual annuities for pension scheme members in the open market should the scheme be wound up by the buyers.
The problem for private equity firms is that they have tended to assume that if they do not have any requirement to meet a deficit under FRS 17 then they can safely assume that they can overlook trustees' demands for pension payments on the grounds that the Regulator would be unlikely to intervene in the trustees' favor. This is an assumption now very much open to question.
While there is no law that prevents a buyer from overlooking pension payment demands when it acquires a company, it would not be the end of the matter. All pension schemes are subject to tri-annual valuations and, at this point, the Regulator can impose its own verdict on the required size and timescale of any pension payments should the owners fail again to meet the trustees' demands. The latest pronouncement from the Regulator makes it more likely that any intervention will be in trustees' favor.
One legal source told PEI Manager that some private equity firms have been taking the view that the Regulator is something of a toothless tiger that is not inclined to use its powers and can be safely ignored. This is a view that the Regulator is aware of and wants to challenge, says the same source, adding: ?They want everyone to be worried.?