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back to index backGLOBALtalk May,  2007

On shaky ground: Pension risk of greater concern in Europe

Fifty-six percent of large global companies believe their pension plan represents at least a "moderate" financial risk to their organization, while another 16% say it poses a "great" risk, according to a new global study of 312 companies by Mercer Human Resource Consulting.
European employers are most worried about their pension liabilities; 29% in the U.K. believe the risk is serious, closely followed by 24% in Continental Europe. In contrast, only 9% of U.S. companies consider themselves at great risk. Of the other countries covered by the survey, including Canada, Australia and New Zealand, 16% on average think their pension plan poses a great risk.

Greater concern among U.K. companies is not surprising, given that their average pension exposure is almost twice that in the U.S., notes Mercer. The average gross pension liability for companies in the S&P 500 is 15% of market capitalization, compared to an equivalent figure of 28% for FTSE 100 companies.

In addition, "Europe has already experienced increased pension regulation and greater pressure for transparent accounting," says Bob Moreen, worldwide partner at Mercer in Philadelphia. "The trend is now growing and, more recently, has manifested itself in U.S. changes such as the Pension Protection Act and FAS 158."

Plan design changes

As a result of increased risk, 60% of the survey respondents have made changes to their benefits or are planning to in the next two years. The highest proportion of employers amending their plan designs is in Continental Europe (78%), followed by the U.K. (72%) and the U.S. (54%). Sixty percent of companies in Continental Europe and 50% in the U.K. have closed their defined benefit plans to new members in the past two years or plan to do so, compared to 40% of U.S. employers. Twenty-four percent in Continental Europe, 22% in the U.S. and 14% in the U.K. said they are likely to freeze their plans altogether.

As an alternative to DB plans, 69% of Continental European companies are introducing or enhancing their defined contribution plan, as are 54% in the U.S. and 52% in the U.K. Survey respondents also indicated they are changing investment allocations. In the next two years, organizations expect to consider:

* Increasing allocations to fixe- income investments (30%)

* Increasing allocations to hedge funds, private equity vehicles and/or infrastructure investments (26%)

* Hedging interest-rate risk (26%)

"There has been a lot of talk about increased liability matching, but now plan sponsors and trustees seem to be putting words into action. The use of derivatives for this purpose appears to be growing rapidly in the U.K. and Europe, while U.S. funds are focusing on directly matching bond investments," comments Tim Keogh, Mercer worldwide partner in London.

Germany's liabilities highest

In a separate study published earlier last year, Mercer reported that the largest German-owned companies have almost 20% more exposure to pensions risk than top U.K. and Dutch firms. and over three times more than French-owned organizations, according to research by Mercer Human Resource Consulting. The 2006 analysis, designed to help investors assess pensions risk in the major European financial markets, also shows that a significant proportion of pension liabilities in German companies remains unsecured by assets, despite large-scale voluntary funding by some firms.

The combined value of pension liabilities in the biggest German-based companies (the DAX 30) is equivalent to 31% of the organizations' market capitalization, Mercer states. This pension risk exposure is around a fifth higher than for the top U.K. (FTSE 100) and Dutch (AEX 25) companies, which have liabilities equating to 26% of their market capitalization.

Furthermore, the largest French-owned companies (CAC 40) have pension liabilities equivalent to just 10% of their market capitalization, meaning their risk exposure is less than a third of that of German companies.

In comparison, pension liabilities in the top U.S. companies (S&P 500) amount to 15% of their market capitalization.

"The research shows how much risk top European companies are shouldering in their pension schemes," commented Keogh. "Pension liabilities have a large bearing on the financial structure of major German-owned companies, with U.K. and Dutch-based firms following shortly behind.

"Even if schemes are well secured by assets, they are still exposed to longevity risk. If life expectancy increased by 10%, the effect on German companies would be 20% greater than on U.K. and Dutch firms and three times more than on French organizations," Keogh added.

Many of the large European companies are multinationals and much of their pension exposure lies outside their home country, he pointed out. For example, French companies may have little pension exposure in France, but significant liabilities through subsidiaries in the U.S., U.K. and Germany, where defined benefit pension provision is far more prevalent."

Pension contributions

Mercer also noted that while German companies have a significant proportion of unfunded pension liabilities, they are ploughing more money into their schemes than needed to cover the cost of new benefits. In 2005, large German-owned companies contributed GBP3.27 for every GBP1 of new pension benefits credited to employees, compared to GBP1.82 by the top French firms and GBP1.56 by organizations in the FTSE 100.

"Interestingly, German-owned companies are volunteering to make large contributions to their pension schemes without any legal obligation or tax incentive. Traditionally, German firms simply treated their pension commitments as a balance sheet liability, along with other long-term borrowings, but attitudes are now changing," said Mr. Keogh. "One reason companies give for making large pension contributions and taking pension assets and liabilities off the balance sheet is to improve reported company performance and credit ratings."

Source: Benefitnews.comGAI

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