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UK banks underestimate pension obligations

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The pension deficits of Europe’s major listed companies were underestimated by EUR300bn in their last full year reports with some of the largest gaps at UK banks, according to AlphaValue, an online provider of pan-European equity research.

Research by AlphaValue reveals the most underestimated funded obligations, in value terms, were those of Lloyds, RBS, British Airways, Siemens, Barclays, RD/Shell, HSBC, GSK, BT Group, ING and EDF.

In percentage terms, AlphaValue believes there are 31 firms with obligations underestimated by 40 per cent or more and above EUR1.5bn.

Conventional estimates of pension deficits (measured through corresponding provisions) for Europe’s largest listed companies grew by 22 per cent to EUR280bn. But there is an additional EUR300bn – equivalent to nine per cent of the total shareholders’ equity of the European companies analysed by AlphaValue – that has been unrecognised, most notably through the use of high discount rates.

AlphaValue breaks down obligations into funded (covered by a pension fund or an insurance policy); and unfunded (paid through cash flow). Most European corporates do not readily provide this breakdown but AlphaValue has made calculations through the analysis of pension payments.

It says the basis of the miscalculations is through companies underestimating wage inflation and overestimating the opportunity cost of money (discount rate).

Some companies, particularly those that are UK-based, attempt to keep the lid on pension obligations by minimising projected rates of future salary increases and maximising the discount rate.

In 2008, the average wage inflation rate declined to 3.6 per cent from 3.7 per cent, and the average discount rate increased to 5.57 per cent from 5.38 per cent (4.9 per cent in 2006). This 30bp improvement in the “spread” may look insignificant but it is not when applied to EUR1,100bn of obligations. A rough indication is that this 2008 “spread” saved European corporates about EUR51bn in extra provisioning.

Pierre-Yves Gauthier, director at AlphaValue, says: “More than one-third of 2008 pensions obligations – some EUR1,100bn – are recorded at UK companies, as this is where the largest companies operate with the largest defined-benefit commitments. The bulk of the ‘non-accounted-for’ pension deficit is also with UK corporates, especially the banks, as they use rather high discount rates compared with non-UK peers.

“A number of companies have made sharp corrections in their valuations over the last few quarters. However, difficult market conditions make it even more important that more consistency be found across European corporates on the use of coherent discount rates in particular.”

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