黑洞社区

Imagine you awoke one morning to find an enormous silverback gorilla in your garden eyeing you through the window. What would you do? There are a few sensible responses to such an alarming scenario but closing the curtains and ignoring the situation is surely not one of them.

Yet that is the metaphor cited by one expert to highlight what many companies are doing in regard to their hugely indebted final salary pension schemes.

Final salary or 鈥渄efined benefit鈥� schemes - a generous type of plan where retirement income is based on a percentage of your salary every year for the rest of your life - have largely been closed to new members due to their cost but they remain a massive headache for many construction firms.

This was thrown into stark relief last week when 黑洞社区 revealed that consultant Currie & Brown had been struggling with a hefty 拢31m pension deficit. Consultant Dar Group was able to to acquire the firm without taking on the debt, thanks to the fact that Currie & Brown had undergone a pre-pack administration that transferred the deficit to the government-backed safety net, the Pension Protection Fund, immediately prior to the firm鈥檚 sale. Under this arrangement, members who are yet to retire will see their annual payments limited.

This is like asbestos was for the industry - a toxic legacy for companies

Richard Farr, BDO

But Currie & Brown is simply one example. According to figures from the Pensions Regulator and the Pension Protection Fund, the total liabilities of the construction industry鈥檚 200 final salary pension schemes were 拢33.4bn as of June last year - the latest figure available.

This figure has risen two-thirds in just five years - from 拢20.4bn in 2007 - and represents just a small part of the UK鈥檚 total final salary pension scheme liabilities, estimated at 拢968.5bn last year.

Though the assets of construction industry pension schemes marginally exceed their liabilities, 7% are being investigated by the regulator because they are in potential trouble.

As pensions expert and BDO partner Richard Farr - who came up with the gorilla metaphor - says: 鈥淭here鈥檚 a serious problem in the construction sector with defined benefit schemes and Currie & Brown is a small example of that.

鈥淭his is like asbestos was for the industry - a toxic legacy for companies.鈥�

It is actually another renowned UK consultant - Halcrow - which better illustrates the gorilla scenario, some would argue. At the time of its sale to American infrastructure and engineering giant CH2M Hill last September, Halcrow was struggling with a pension deficit worth 拢149m on an ongoing or cash basis, 黑洞社区 can now reveal. Worse still, it would cost Halcrow 拢410m to offload the liability, according to an estimate by risk management firm Towers Watson.

At the time of the deal, trustees of the scheme appealed to then Halcrow chief executive Peter Gammie to use the sale process to fill the black hole amid what they then described as the firm鈥檚 鈥渨orsening鈥� financial position.

In the event, it is shareholders, not the scheme, who stand to benefit from the sale, leaving the deficit largely unchanged (see case study overleaf).

The root of the problem

So just what do final salary pension schemes mean for the construction industry and what do companies need to do to prevent them spiralling out of control?
The roots of the problem lie in the popularity of such schemes in the seventies, eighties and nineties. Construction was particularly vulnerable as a labour-intensive and low-margin sector offering final salary pensions as part of a range of unionised benefits.

Back then, final salary pension pots grew rapidly and were widely seen as an asset rather than a liability. It seems hard to believe now that firms were even encouraged to take 鈥渃ontribution holidays鈥� during the dotcom boom of the nineties and tap the funds for investment capital, storing up further problems for the future.

Today, after more than a decade of poor stock market performance, poor gilt returns and, crucially, a population living significantly longer than anticipated when such schemes were dreamt up, the schemes are a recipe for disaster.

The pensions crisis has been exacerbated by recent factors such as the 2008 financial crash and the current eurozone woes, as well as by low interest rates and unpredictable inflation.

While the results pose a threat to both contractors and consultants, many believe that the latter are more exposed because they generally have more directly employed staff and a higher proportion of well-remunerated white collar workers.

鈥淭hese are millstones around construction firms鈥� necks,鈥� says Richard Saxon, a former chairman of architecture practice BDP and former RIBA vice-president.
He argues that final salary schemes are a particular problem for construction firms because of their low margins - a situation which makes paying off the debt an extremely slow business. In the meantime, the deficit simply 鈥渁ttacks your balance sheet鈥� and makes your business less attractive to potential suitors.

鈥淵ou have to top up the pension fund from profits - it鈥檚 a time bomb under all sorts of companies,鈥� he adds.

鈥淭hrough mergers and acquisitions, you often find out that a firm is worth less than the deficit on its pension. A firm may regard you as viable in all other respects, but if there鈥檚 a huge pension hole, this may put them off.鈥�

BDO鈥檚 Richard Farr says that to tackle this firms must identify and calibrate the level of risk and monitor it continuously, while developing a strategy to deal with it. This takes both cash and careful management, as a whole host of big names, including consultant Atkins and contractor Lend Lease, have discovered.

According to Atkins鈥� latest annual report, published last July, the firm had a pension pot funding deficit worth 拢293m in cash terms as of March 2010.

The firm said this week that it had completed a consultation process with final salary scheme employees in January over a proposal to remove the link between employees鈥� accrued pension and future increases in salary. A spokesperson said: 鈥淎s a result of the changes agreed with each member during the consultation process, these staff have now become deferred members of the pension plan.鈥� He added that members would enjoy various benefits including inflation-linked returns.

As for Lend Lease, it has made at least two major changes to its pension schemes in the UK in the past four years to reduce its deficit. The company adjusted its generous defined benefit 鈥渋ndex-linked鈥� scheme last summer while its final salary scheme closed in 2008.

A Lend Lease spokesperson told 黑洞社区: 鈥淭he decisions we have taken over our pension scheme have reduced the deficit so that it is comfortably within our means to manage. Going forward we expect to continue to offer our staff attractive pension contributions.鈥�

Some firms of course may be tempted to park problems with final salary schemes because of the 20-30-year timeframes they operate within, and many chief executives and financial directors believe they have more pressing issues to deal with. Farr understands this temptation but argues against it, warning that it is vital to be pro-active. 鈥淭hese deficits are going to stop investment, stop companies growing, force re-capitalisation and force the selling off of firms, he says.

鈥淢ost firms put their heads down and hope it will go away, but it won鈥檛. I guarantee it will get worse. There is a trillion pound hole in the UK economy because of pensions and the next five to 10 years will see a massive risk-transfer, either to insurance companies or to the PPF.鈥�

The worst thing you can do, it seems, is ignore the gorilla.

Additional reporting by Iain Withers