Who knew that BP stood not just for British Petroleum but also for British Pensions?
In the aftermath of the Deepwater Horizon oil disaster, rarely has one event come to embody so many of the risks that UK pension funds face today.
Forget the palpitations over the environmental impact and the horror of those advocating some form of socially responsible investing. These are luxuries for pension funds in happier times when the deeper risks associated with financial markets and corporate sponsors are hypothetical numbers hidden deep within performance reports. Now, every passing day serves only to highlight that even the perceived safest of investments carries within it a host of risks.
First, there is the loss in equity value, already highlighted by many other commentators. BP is a major constituent of the FTSE 100 and a core holding in many pension fund portfolios, so any loss there will cause pain. But more importantly, the losses are another blow to the deep faith many defined benefit pension funds have in equities as a means of making good their increasingly worrisome deficits. The thesis was already shaken by the dotcom bust and hobbled further by the credit crunch. This only undermines further the argument that being overweight equities and relying on nebulous future growth is the panacea to chronic funding shortfalls.
Second, there is the issue of dividends. BP was responsible for nearly £1 in £6 of all the dividends received by UK pension schemes - invaluable income when you need cashflow to pay all those pensioners every year. That is now under threat and the recent calls in the US for BP to suspend its dividend till the mess is cleared up will not help matters. The dependence also highlights how the credit crunch has left UK pensions dangerously reliant on a handful of crutches in recent years.
Most importantly, the oil spill has brought sponsor risk front and centre-stage. BP is a company expected to generate revenues of £23bn this year and £4bn of free cashflow annually after paying out dividends and capital investment. Simply put, few could think of a stronger corporate sponsor and the numbers mentioned would have been of great comfort to any trustee wrestling with a deficit. Now, the dividend is under threat; there is talk of punitive damages and drilling bans; and some have even mooted that BP may not survive in its current form.
The financial cost to pension funds (other than BP's own) is limited to only the equity and dividends mentioned above. But the knock to their confidence in their own sponsors will prove to be far more lasting. If the largest and most secure are at risk, then the perceived risks of an unexpected downturn in business is even greater for the other hordes of weaker sponsors that the majority of pension funds depend on for their precious contributions.
BP may still be clinging onto survival, but the sponsor's grip just got a bit looser.
Dr Amarendra (Bob) Swarup is a partner at Pension Corporation
This article first appeared on www.pensionomics.com
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