Why companies with big pension deficits should still be allowed to pay dividends

Philip Green of BHS © Getty Images
Philip Green: entitled to his £400m

Should companies with pension deficits be allowed to pay dividends to shareholders? You probably think the answer to that one is simple: most certainly not. That’s definitely the main thought being put about by those commentating on the BHS debacle (despite the fact that there wasn’t a deficit problem when Philip Green was extracting his vast dividends from the firm). And it isn’t a new one.

At the National Association Of Pension Funds conference in Edinburgh last year, Hans Hoogervorst, the chairman of the International Accounting Standards Board, wondered if it was “misleading” to both shareholders and employees to be paying dividends when the numbers suggested that at some point a company wouldn’t be able to pay out all its pensions (the full speech is here).

Might paying out a dividend when liabilities are so huge, he asked, suggest a kind of stability to the firm that doesn’t exist – a “fake stability”? It was – and remains – an excellent point. But Hoogervorst didn’t go on to recommend any changes to the current accounting rules. He could have pressed, for example, for pension deficits to be added into the profit and loss accounts, something that would make it difficult for high-deficit firms to pay dividends.

And contrary to this week’s popular opinion I think that was the right choice. A pension deficit is not a number that is set in stone; it isn’t a thing. It’s an actuarial concept based on best guesses about future investment returns.

Most funds are advised by pension consultants to calculate their deficit by assuming that the long-term return on their portfolio will knock around the gilt yield. So the lower interest rates go, the higher pension deficits go – the bigger the theoretical gap between what they think they will get in and what they know they will have to pay out.

In practice, of course, we don’t actually know what the deficits will be. The amount the fund has to pay out will be set in stone. But the amount it gets is isn’t. If interest rates rise, deficits will fall. If the funds produce investment returns above and beyond those of gilt yields they will also fall. And, of course, if pension fund trustees have the confidence to assume that their fund will return more than gilts, and use that assumption to calculate their deficit, they can push down their deficit right now (remember it’s a forecast not an actual thing). This, by the way, is what the pensions minister Ros Altman wants them to do – watch out for my interview with her on the matter in next week’s mag.

So, given all this, given that a pension deficit is as much a matter of opinion as anything else, does it really make sense to pay nothing to shareholders when you are in technical deficit? Shareholders are as much stakeholders in the business as employees, so companies have to balance their obligations to both. If they are going concerns (and likely to stay going concerns – unlike BHS) they can and should be able to do so.

Finally, those determined to stop dividend payouts might like to think about where most of the dividends from the UK’s big companies end up – they end up in pension funds.