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Getting to grips with the pension deficits.

Getting to grips with the pension deficits

British Airways is sometimes referred to in the business world as a pension scheme with an airline attached. The deficit in its two main pension schemes - which stands at around £3.7 billion - is so great that the Spanish airline Iberia has insisted on the right to walk away from its proposed merger with BA if the issue cannot be satisfactorily resolved.
BA is not alone among UK companies with major pension problems. Balfour Beatty, BAE Systems and National Grid are among 15 companies in the FTSE 100 facing a total future pension bill that add up to more than their stock-market value. Royal Mail recently reported that it was on course to record a £10 billion pension deficit, while BT has a £9.4 billion one.
Final-salary pension schemes - which pay benefits according to the employee's salary in his or her final years before retirement - are at the heart of the problem. A great recruitment and retention tool in the boom years, they are becoming ruinously expensive at a time of poor investment returns and increasing life expectancy.
Aon Consulting recently estimated that the UK's 200 biggest final-salary pension schemes collectively face a deficit of £88 billion.
BA was among the first companies to close its final-salary pension scheme to new entrants, in 2003. Some have indicated that the airline will have to shut the scheme for existing members, employees, too, if it is to build a robust balance sheet for the future.
In Financial Management's October 2009 issue, Ludlow examines how the UK operation of German domestic-appliance maker Miele went about replacing its defined-benefit pension scheme with a defined-contribution one for all employees.
Actuaries had warned the company in 2006 that the existing small deficit on its defined-benefit pension scheme was likely to become substantial. The scheme's funding level had fallen from 97% to 79%. The deficit funding requirement had moved from zero to 10.2% of staff salaries. Miele's contribution to the ongoing funding requirement had risen to 16.5% and employer contributions to pension costs amounted to 26.7% of staff salaries.
The 360-employee firm considered restructuring the scheme, closing entry to it, moving to a career-average revalued-earnings scheme or closing it completely. It decided to scrap the scheme and offer a defined-contribution pension to everyone instead.
The parent company, which had closed its own final-salary pension scheme some 10 years earlier, immediately approved the plan. The trustees, who had a duty to ensure that any decision was in the best interests of the scheme members, were won over. The chief executive and finance director then explained the changes face to face with every employee. In addition, the company sent letters plus an eight-page newsletter to scheme members, outlining the challenge of balancing employee benefits with business needs. A dedicated e-mail address was created to garner further feedback. And each employee was sent a personalized statement detailing how he or she would be affected by the changes.

Ludlow reports that most employees understood the need for change. Some, apparently, expressed surprise that the company had managed to retain such a generous scheme for so long.
In deciding early on that it needed to act decisively to tackle its pension crisis, and having its senior executives channel large amounts of their own time and effort into getting the changes accepted, Miele UK demonstrated a strong commitment to establishing a solid base for future success.

According to FitzGerald, in the October 2009 issue of Strategic Finance, this kind of long-term, root-and-branch approach to reform indicates a strong corporate will to compete. Such an operating dynamic is, says the author, crucial to company performance, and inspiring and channelling it is a chief executive's main responsibility.

As anyone who has seen interviews with combative BA chief executive Willie Walsh will confirm, he, too, has a strong will to compete. His eagerness to cut BA generous staffing levels and pay to more manageable levels, tackle the company's pension deficit and cement a closer alliance not only with Iberia but also American Airlines, is evidence of it. But strong vested interests and entrenched attitudes are working against him.