An $86 billion UK pension problem may solve itself

Bloomberg

For UK Plc, the sting of Brexit comes with an unexpected bonus.
With no effort on their part, the biggest British businesses may see pension deficits that have burdened them for years be practically wiped out if long-term bond yields rise 50 basis in the next year and they budget for slowing gains in life expectancy, according to estimates of New York-based consultancy Mercer. The Bank of England is expected to raise interest rates by that amount by November 2018 and it remains to be seen if that affects long-term bonds.
That will give executives one less thing to worry about as they prepare contingency plans in case Britain can’t strike a deal on splitting with the European Union. Companies like BT Group Plc and Marks & Spencer Group Plc, whose liabilities are almost double their market value, will also remove a stigma that has contributed to years of under-performance in their shares.
“If you bought a basket of these stocks you would probably make money from here,” said Andrew Millington, the acting head of UK equities at Aberdeen Standard Investments, which owns shares in firms with big pension liabilities like Tui AG, BAE Systems Plc and AA Plc that he expects will benefit.
The idea that corporate Britain could fill holes in staff retirement budgets without slashing dividends would have been unthinkable even a year ago. The shortfalls of FTSE 350 companies had soared to a record $217 billion as the BOE cut rates to spur the economy after the Brexit vote, throttling pension income that relies on higher bond yields. But companies have been “climbing out of a pit” since then, according to Glyn Bradley, principal of UK wealth at Mercer. The gap dropped to an 18-month low of 65 billion pounds in September, partly because pension fund managers made more on their equity investments as the FTSE 100 rallied 8 percent in the past year.
Not all investors have noticed the U-turn. The 14 firms with the biggest liabilities relative to market value have trailed the FTSE 350 by 10 percentage points since Brexit, according to data by Bloomberg and RBC Capital Markets.
The game changer will be if BOE Governor Mark Carney raises interest rates to contain inflation triggered by the pound’s post-Brexit decline.
Traders see him hiking rates by 50 basis points in the next 12 months, possibly starting as early as the BOE’s November 2 meeting. If the long-term yield on corporate bonds moves by the same amount, that could potentially bring the pension deficit down to about 12 billion pounds, according to Mercer estimates based on current conditions.
What’s left of the shortfall, meanwhile, could be eliminated if listed companies used the latest longevity forecasts from Continuous Mortality Investigation Ltd. in their retirement budgets.
Last year, CMI cut projected lifespans for people aged 65 versus the 2013 figures many companies still plug into their models.
“We may well start to see the aggregated deficits across the defined-benefit universe disappearing, perhaps even moving to a small surplus over the next year or so,” Bradley said from Manchester.