Just wondering of people's approach to pension deficit's as I seem to like many business's but they often have large Pension deficits that put me off.
Is there a good metric to use to enable decicsion making ?
Good question. I have spliced together a couple of comments that I left on a SCVR a few days ago to get the ball rolling.
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I allow for pension deficits in my valuations the same way I allow for debt. I add back the contributions to fund the deficit (net of tax) to income before applying a valuation multiple and I deduct the deficit (net of deferred tax credit) from cash in making my cash/debt valuation adjustment.
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Yes, a pension deficit involves a high level of potential variability that is very different from a debt. I think that the only way to try and model this accurately would be through stochastic simulation using an economic scenario generator, but this is hardly realistic for most of us.
If you want to impose a "charge" on your valuation to reflect the potential for the deficit to increase, I would suggest basing that on the sensitivity tests in the full results. These sensitivity tests cover the discount rate (+/- 0.5%), inflation rate (+/- 0.5%) and life expectancy (possibly +/- 0.5 years). Take the biggest of these, which is the discount rate for T Clarke (LON:CTO), with a 0.5% decrease increasing the pension liabilities by 12%, which is £6.4m.
You would need to give some thought as to how to calibrate this adjustment, as sensitivity tests are not standard. For example, Macfarlane (LON:MACF) reports on movements of 0.1% and 0.1 years and quantifies the impact on the deficit, rather than the obligations alone. (This makes sense for them as they hold substantial liability driven assets that are intended to hedge against movements in the value of the liabilities).
Anyway, suitably calibrated, this method would provide a sensible adjustment for DB pension risk that would also reflect the riskiness of individual schemes.
It's all too complicated for me, however. At the moment, I just take the view that any discount rate shocks are much more likely to decrease the deficit (higher discount rates than implied by the current yield curve) and that, therefore, future uncertainty on the pension deficit is biased on the favourable side.
