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Take It Away

CFOs in Britain now have a number of ways to offload pension schemes.
Tim Burke, CFO Europe Magazine
February 4, 2008

Ian Griffiths is used to dealing with pensions. As finance director of Emap, a £884m (€1.2 billion) UK media group, the topic has been discussed at every board meeting he's attended since his appointment in 2005. But the future of the company's two defined-benefit schemes took on a new relevance last July.

That's when its pensions — the first being an old Emap scheme, the second linked to Scottish Radio Holdings, which it bought in 2005 — were put under review as part of a larger discussion about whether Emap should sell its radio and magazine divisions. The big concern was the pension deficit — a gaping hole of £8m (on an IAS19 basis as of September 30th 2007). Griffiths and other Emap executives wanted to avoid the drawn-out discussions that could develop if an acquirer was worried about the schemes. "I've always been of the view that if it's possible, we shouldn't let the pension issue — because clearly it is an issue, as it's a cash requirement — get in the way of the business strategy," Griffiths says today.

To find a solution, Emap turned to Paternoster, a two-year-old pension insurance firm that buys out companies' schemes. Its clients include a UK subsidiary of Italian energy group Eni and P&O, a shipping company owned by Dubai's DP World. Firms such as Paternoster and Pension Corporation are making a name for themselves in the buyout market alongside established insurers such as Legal & General and Prudential.

Pension buyouts are nothing new. The market developed in Britain following the Pensions Act 2004, under which the pensions regulator can force companies to address any deficit in their scheme. Insurance groups responded by offering to buy out pensions and take them off the balance sheet.

What is new is the type of company that decides to offload its plan. Once used only by companies to wind up small schemes during insolvency proceedings, pension experts reckon buyouts will become increasingly popular among healthy businesses and those considering other types of deals, such as Emap's strategic review.

Wrestling with Risk
Until now, however, "there has been a lot of inertia," says Charlotte Crosswell, a partner at Pension Corporation. Scheme trustees have generally been the party to consider a buyout, she says, although many have been put off by the cost or the fact that it's a relatively new industry. But Crosswell adds that recently more CFOs have been asking the firm about their options. As more high-profile deals are announced, she says it may not be long before shareholders too call for the certainty that can come from insuring a company's pension scheme.

One reason for the buyout experts' optimism is the relatively good shape that pension schemes are now in. Risk consultancy Aon claims that almost half of all UK schemes have started 2008 with a surplus, so if any one did a buyout, it could transfer its pensions without having to inject more money. "When you've been wrestling with a pension scheme for years, that's an enormously attractive proposition," says Mark Wood, founder of Paternoster.

Crosswell cites another attraction — flexibility. A buyout can be structured to insure pensioners, active employees or both. And an insured buyout isn't the only way of getting the scheme off the books. Pension Corporation has completed several deals in which it bought companies outright because it wanted access to their pension schemes. What's more, Crosswell says it is equally happy to look at subsidiaries that can be tied in and sold alongside a company's pension.

But for many companies the cost of a buyout is prohibitive. When consultancy Watson Wyatt polled 100 UK companies in early 2007, one in four said it would transfer its plans to an insurer within five years, but only if the cost was low enough. They may get their wish — buyouts have tended to be priced at about 130% of a scheme's liabilities under IAS19, although increased competition between insurers has seen that fall.

But even if costs come down, Patrick McCoy, head of KPMG's investment advisory group, says some CFOs will still want to extract the value in a pension themselves. As he sees it, "it doesn't take too long for intelligent chief executives or CFOs to say, 'Hold on a second, if [buyout providers] want to get their hands on these assets, they must have some value, so am I acting in my shareholders' best interests in transferring value to some third party?' In some cases yes, in some cases no."

Indeed, many respondents to Watson Wyatt's survey said they would look at other ways of containing their pension liabilities. Some are focusing on risk management and using insurance company techniques such as liability-driven investment to reduce liabilities. Others are concentrating on changing the assets they invest in to boost funding.

You're Breaking Up
For Emap's Griffiths, offloading the defined-benefit plans made the most sense. The company had received unsolicited approaches for parts of its business ahead of its review, and removing any uncertainty about the pension deficits would reassure potential buyers that they wouldn't be liable for further funding. The finance director says the company had discussed a buyout before considering a break-up, but the strategic review increased the urgency. "It just got rid of another area of debate, discussion, negotiation," he says. "Anything you can do to cross off uncertainty as you're going through something like this is important."


Emap's deal was different from others, however. In most cases, a pension-buyout provider can demand more money from the original sponsor if the value of a member's pension is found to be greater than initially thought, for example. But Emap wanted to ensure that potential buyers would have no responsibility for the pension, so the group insisted that any buyout insurer take on all risks with no recourse. Paternoster agreed to take on all future liabilities of the £170m of pensions, including risks associated with incorrect data. As part of that agreement, Emap put £38m into the schemes before passing them over. It was a competitive quote, cheaper than the £77m liability calculated on a buyout basis in the group's last actuarial valuations.

Emap was in a better position than other companies. Its schemes had been closed for some years and had fewer than 20 active members. Together with its healthy balance sheet the group was well placed to consider a buyout. Griffiths thinks other CFOs in a similar position should consider such moves. "The risks for shareholders — because what we're talking about is the use of shareholders' funds — [are] something that's likely to increase, primarily by uncertainty. So deal with the issue if you can," he advises.

It can be a gruelling process. Griffiths and Paternoster's Wood often called each other before six in the morning and after ten at night to discuss details. But completing the deal seems to have been worth the effort. In December, Emap announced that it was selling its radio and consumer magazine divisions to Germany's Bauer for £1.14 billion, while private equity house Apax has teamed up with Guardian Media Group to make a recommended £2 billion offer for the remaining PLC business. According to Griffiths, the buyers were happy that Emap had used a pension buyout to deal with an issue that they would otherwise have had to handle themselves.

"Two years ago, we couldn't have done this deal," Griffiths says. "I don't think the market was established enough or dynamic enough. But I think it is now — and I think we've done a really good deal for everybody."

Tim Burke is senior staff writer at CFO Europe.




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