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Derailed by Pensions

Derailed by Pensions

You may have seen Richard Branson’s recent blog, predicting that his Virgin Trains business could be gone from the UK by November after shareholder Stagecoach was disqualified on three rail franchise bids. The reason for Stagecoach’s disqualification was its refusal to meet the stipulated requirements for pension provision. On the one hand, the moral of the story is simple: don’t bid for a contract if you can’t meet its requirements. Indeed, other bidders for the rail franchises agreed to meet the pension requirements, so why couldn’t Stagecoach?

However, this story is also a reminder of the ongoing debate around the affordability of defined benefit pensions generally, in both the public and the private sector. Clearly, Stagecoach doesn’t consider taking on defined benefit liabilities to be economically viable, given the risks and inherent uncertainty involved. We’ve also witnessed the cautionary tales of past buyers who have perhaps been too optimistic, or cavalier even, about the pension liabilities they are taking on (see BHS).

While the Pensions Regulator has previously stated that it considers defined benefit pensions to be affordable still, many prospective bidders or investors might disagree after they take into account all the other risks a business must account for. The reality is that defined benefit pensions remain expensive, and carry risk, whereas the auto-enrolment vehicles used by the majority of modern employers are comparatively cheap, even after the recent increase in minimum contributions, and their cost is certain.

Of course, for a savvy investor who is well-versed in pensions solutions, defined benefit pensions can present something of an opportunity. That investor can go in with a strong plan to rationalise or de-risk the pension, while rivals are put off by the potential overheads. There are many tried and tested techniques to manage the risks and costs involved in defined benefit pension schemes: benefit restructuring, incentive exercises, flexible retirement options, ABCs, PPF guarantees, LDI and longevity swaps, are just a few that spring to mind.

In addition, new possibilities are identified all the time – most recently, consolidated defined benefit schemes are being explored as a potential solution for employers to transfer risk from their balance sheets.

While it is clear that for many employers defined benefit pensions are simply unaffordable, it is equally clear that it is always possible to flourish in difficult environments when you have an edge on your competitors, and that edge could be a robust appetite for risk and a clear strategy to manage pensions.

Margeret Meehan
Partner

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