By Ilonka Oudenampsen
Defined benefit (DB) pensions are still causing a significant dilution of company earnings for European multinationals and are now larger relative to market capitalisation than in 2006, even though corporate earnings have increased since 2008, Mercer has found.
Pension deficits account for 4.8% of market cap in 2010/11 compared to 2.9% in 2007/8 and pension costs now represent around 10% of earnings.
The Cyclical Consumer Goods sector has the highest pension deficit to market cap at 12.7%, while at 2.2%, the Communications and Non-Cyclical Consumer Goods sectors had the lowest ratio. German companies have the highest level of pension deficit relative to market cap at 11.7%, followed by French (7.7%), UK (3.1%), Dutch (2.1%) and Swiss companies (1.8%).
“Because so many of the large European companies are multinationals, they remain exposed to pensions even if the pension systems in their home country do not rely on private defined benefit pension structures as in the UK, the Netherlands or the US,” said principal at Mercer and author of a white paper on managing cross-border pension risk Julien Halfon. “Foreign exposures drive a large part of the pension issues for these multinationals.”
Funding levels for the Eurostoxx 600 have remained relatively stable since 2006 and stood at 81.7% for 2010/11. Total liabilities increased from €1.17trn in 2007/08 to €1.29trn in 2010/11, whilst total assets increased from €1.01trn to €1.06trn during the same period.
In order to investigate how companies manage their cross-border pension risk, Mercer has analysed six years worth of reports and accounts for 228 companies listed on the Eurostoxx 600. The research focused on companies with pension liabilities above €500m to assess the scope, extent and implications of multinational pension exposure in Europe.
Halfon said: “DB pension plans sponsors across the globe are accelerating efforts to manage their pension risk and ultimately transfer it to external parties. However, this is a slow process and in the meantime, many companies still do not have proper oversight and governance of pension schemes risk.
“A company operating in just one market is exposed to a range of risks that need monitoring: investments, contributions, changes in liabilities and changing regulations, policies and strategies. In contrast, a multinational must deal with the compounded effect of all these issues across different regulatory and pension regimes and in a number of currencies. This can introduce significant risk and volatility at the corporate level and can hurt key financial metrics, which are of interest to analysts and rating agencies. Therefore, for multinationals, pension scheme governance and risk management must be considered together.”
He added that there are several key stages in the establishment of a multinational pension risk management framework. “First, companies must be sure who should assume overall accountability for this area. It is crucial that this is seen as the main priority. Establishing ownership leads to the creation of policies and processes which, in turn, leads to the establishment of central and local investment and risk management strategies. Implementing regular assessments of changing risk levels within a well managed governance framework must be supported by regular communication with all advisors and internal stakeholders. Not maintaining this oversight will often lead to companies falling foul of changing local regulations or failing to address the pensions challenge.”
The research showed that 35% of companies had exposure in the eurozone, 27% in non-eurozone Europe, 16% in North America and 22% elsewhere. On average, European multinationals have pension exposure in at least three countries beyond their own, with companies headquartered in the UK and Switzerland having average pension exposures in less than four countries. Those in France and the Netherlands have exposure to five, and those in Germany to four. These five countries account for 90% of total pension liabilities and 91% of total pension assets.
Companies in Basic Materials, Financials, Industrials and Non-Cyclical Consumer Goods have pension exposures in an average of four countries, whereas companies in the Cyclical Consumer Goods sector have on average exposure in less than four countries. These five sectors account for 75% of total pension liabilities and 74% of total pension assets.
The multinationals paid contributions to their pension schemes of on average €43.8bn a year, with €42bn in 2006/7, €46bn in 2007/8, €44bn in 2008/9, €43bn in 2009/10 and €44bn in 2010/11. Mercer found that the level of contributions has remained stable even during times of reduced corporate cash flow. However, the ratio of pension contributions to free cash flow varies considerably across different industry sectors. Last year, contributions were 38.1% of free cash flow for Utilities compared to 3.1% for companies in the Communication sector.
Mercer’s global head of DB risk and senior partner Frank Oldham said: “Many countries have significant DB pension obligations. Plan sponsors are suffering the burden of persistently low interest rates, volatile equity markets and rising life expectancies – exacerbated by the protracted economic downturn. Pension deficits vary significantly across many markets and present CFOs with increasingly unwelcome pension distractions. However, tackling the issue across multiple geographies is a real challenge for multinationals, as the individual components in different countries often move in different directions at the same time. Having strong governance with regular monitoring and oversight is critical to making the most of company resources.
“As organisations seek to control their obligations, we are likely to see further developments in the transfer of this risk across Europe and globally, building on the increasing number of longevity deals and annuity purchases – which, just six months into the year, already looks set to reach new levels in 2012.”