Scaremongering about pensions lifeboat overdone

PPF can handle UK Coal

This may be another sign of watering down full buyout standard for employers

Reports suggest PPF about to take over UK Coal pension fund and assets – its biggest scheme so far: It looks likely that the UK’s recently restructured coal industry will be restructured once more, following the devastating fire at its largest coal mine, Daw Mill. The Pension Protection Fund (PPF) will take over the company’s remaining working coalmines and property assets, together with the underfunded pension scheme whose liabilities of around £543m would make it the largest scheme so far taken into the UK’s industry-funded pensions lifeboat.

Concerns about PPF capacity and competence overdone: Concerns have been expressed about the ability of the PPF to absorb such a large scheme and also about its competence in running the assets it is taking over. I believe both those concerns are overdone.

PPF budgeting allows for large schemes: The PPF has always assumed it would eventually need to take on some large pension schemes. Its financial forecasts have budgeted for a few large firms to fail, and the fact that UK Coal would be the largest to enter PPF should not be a cause for undue alarm. In its recent three-year plan, it said it expected to take on up to £1.4bn of liabilities this year and £1.8bn next year, but it also has capacity to absorb more. Until now, the PPF has successfully managed its investments and improved its funding ratio, while also ensuring that it manages risks carefully. Imminent warnings of funding problems for the pensions lifeboat are, in my view, very much overdone.

PPF has access to professional business expertise: The PPF also has access to significant business expertise, with the Pensions Regulator itself having professionals with backgrounds in business management, restructuring and turnarounds. Therefore, the fact that the PPF will be taking on coal mines and a property portfolio does not mean these will be run by civil servants. I expect them to be run competently and professionally to deliver value to the PPF. This investment is clearly higher risk than investing in large quoted equity or corporate bonds, however it is similar to investing in private equity or small turnaround situations which have the potential to deliver longer term returns.

Coal business in trouble, but national energy security also important: As the rump of the old British Coal, the quoted company UK Coal owned three deep mines and six surface mines that kept UK coal production going. It even managed to make a profit in 2011, however as the US shale gas revolution has driven down coal prices and US coal producers are now competing to offer lower priced coal in Europe, the UK coal operations were financially fragile. The company had already seen some restructuring, however the Daw Mill fire made its ongoing survival financially impossible. The cost of the fire, estimated at around £300m, was beyond the company’s resources to absorb.

Loss-making Daw Mill will be handled by quango: The Daw Mill operations will, according to the reports, be handed to the DECC-sponsored quango, the ‘Coal Authority’ while the PPF will help rescue the profitable bits and hopes to use its profits to add to enhance asset base over time.

Pensions reduced by around 20%: The sad reality of UK Coal’s demise will result in its workers facing reductions of around 20% in their future pensions. By transferring the pension scheme to the Pension Protection Fund, the scheme’s 6,800 non-retired workers and former workers will have their pensions reduced to 90% of the PPF’s measure of liabilities, and much of their inflation linking will be either reduced or removed. However, the aim is to save as many jobs as possible, by ridding the company of its unaffordable liabilities and also ensuring that UK coal production continues, to assist domestic energy security.

Is this another sign of watering down pension protection?: The interesting aspect of this deal is that it may be another tentative sign that the UK authorities are starting to accept the possibility that historic pension promises may be beyond the capability of many companies to guarantee. At the moment, employers have to underwrite full benefits, to the level of annuity buyout, for all members. Any corporate restructuring or offloading of risk has to entail benefit buyouts. Funding calculations and scheme recovery plans target full benefits either on an ongoing or cessation basis. However, if the employer cannot afford this level of benefits, and the business is struggling, the firm may be pushed into insolvency by its pension obligations. Once it is insolvent, members do not receive full benefits anyway, since the PPF always entails benefit reductions. Therefore, it has been suggested that members could be better off if the employer can fund benefits above the PPF level, even if it cannot afford the liabilities in full. By allowing or countenancing the possibility that businesses can offload their pension schemes if they are in such a dire financial condition, while meeting at least PPF benefits, the bar for final salary pension protection is reduced. The recent Kodak deal, which allowed the sponsoring company to exit Chapter 11 while only offering PPF benefits or somewhat above, but rather than having to match previous pension promises in full, has already signalled the Regulator’s acceptance of watered down employer obligations. This may be a reflection of current economic circumstances, or it could be the way of the future. Time will tell.