Companies may face cash flow squeeze if forced to plug pension deficits

Cash flows of non-financial companies could come under threat if they are forced to stump up extra money to plug deficits in their UK-based pension plans as a result of triennial funding valuation updates that fall due in 2016-17, according to Moody's. Every three years, companies with UK pension plans have to assess if their investment return assumptions, which play a key role in determining the scale of their pension obligations, remain appropriate.

"In today's low-yield environment, companies will likely have to lower these assumptions, which usually means having to pay more cash into the pension plan," the ratings agency said.

Pension liabilities reported on balance sheets are rising as sterling interest rates fall – a development given fresh impetus by monetary policy easing from the Bank of England following the Brexit vote – but there is no direct link between the liability on the balance sheet and the cash contributed to funded pension plans in the UK.

While many firms voluntarily provide information that is helpful to investors, half of the 20 companies included in Moody's investigation did not quantify the funding deficit, and only two – AstraZeneca and BT – volunteered fully comprehensive information, including the key investment return assumption.

Moody's said when BT Group updated the 30 June 2011 funding valuation for its largest pension plan as at 30 June 2014, using a more prudent view of the likely future return on the plan's investment portfolio, the cash outflow committed under the recovery plan (excluding contingent payments) increased from £4.7bn to £9.6bn.

However, in many cases companies will offset their cash flow exposure through risk reduction initiatives, such as insurance contracts that reimburse the benefits payable to current pensioners, and liability driven investment portfolios designed to offset interest rate and inflation rate risks.

Trevor Pijper, senior credit officer at Moody's said, "Companies aren't required to report funding valuation results in their annual accounts. This makes it difficult for investors to identify the firms affected by an impending funding valuation update, and the scale of the threat to their cash flows, from publicly available information."

However, in many cases companies will offset their cash flow exposure through risk reduction initiatives, such as insurance contracts that reimburse the benefits payable to current pensioners, and liability driven investment portfolios designed to offset interest rate and inflation rate risks.