AkzoNobel valuation results in £550m Q1 funding call

In its annual report for 2018, the Dutch conglomerate had predicted the payment of €552m into its defined benefit plans, of which the UK-based ICI Pension Fund and Akzo Nobel (CPS) Pension Scheme account for the vast majority of a total €13.7bn in assets.

But negotiations over a triennial valuation of the schemes concluding in February this year have led to the company exceeding this forecast in one quarter.

The use of an escrow account is good risk management for the company as it protects against any potential trapped surplus

Simon Taylor, Barnett Waddingham

Top-up payments of £290m were paid in relation to deficit-recovery plans for the two largest schemes, along with payments of £129m in accordance with the previously agreed recovery plans.

A further amount of £142m of pre-funding was paid into an escrow account for the Akzo Nobel (CPS) Pension Scheme.

Schemes close in on full funding

Despite the massive cash injections, the company’s main schemes appear to be in rude health. A March summary funding statement for the ICI scheme showed it to be 95 per cent funded at the date of its actuarial valuation on March 31 2017, with its deficit having shrunk from £850m to £604m over the three years.

In the year since the £10.1bn scheme’s valuation, funding has further improved to 96 per cent, with a deficit of £414m. The scheme has an unlimited guarantee from AkzoNobel for its liabilities, meaning it would not be stranded if the Dutch company sold off or liquidated the subsumed sponsor ICI.

The Akzo Nobel UK scheme has not published an annual report on its website since 2017, but was 97 per cent funded in technical provisions in 2015. AkzoNobel could not be reached for comment.

Possible explanations for the lumpy contributions could include the Dutch company’s exposure to foreign exchange movements when contributing to its UK schemes, according to one expert.

Simon Taylor, partner at Barnett Waddingham, explains: “It’s possibly an exchange rate reason for doing this – it is cheaper to fund UK DB from overseas given the fall in sterling post Brexit referendum.”

AkzoNobel appears to have its eye firmly on what is often called the ‘end-game’ for its major UK schemes. Both are well funded, and the ICI scheme has undergone extensive buy-in activity with a range of insurers under an umbrella contract. In 2016, it had covered about 75 per cent of liabilities with bulk annuity contracts, worth around €7.5bn in the company’s latest annual report.

“There is a history of annuity transactions in the schemes, so additional funding reflects a realistic long-term funding target,” Mr Taylor says.

“The use of an escrow account is good risk management for the company as it protects against any potential trapped surplus.”

Dividends eclipse contributions

While the AkzoNobel’s first-quarter contributions amount to almost 5 per cent of total assets, the company has also made large payouts to other stakeholders.

“While a pension payment of €639m in cash to the main UK pension plans of AkzoNobel sounds, and is, a considerable amount, it pales into insignificance when compared with the group’s dividend policy,” says Penny Cogher, a partner at law firm Irwin Mitchell.

“The EGM of November 13 2018 approved a return of €2bn to shareholders for capital repayment and share consolidation in January 2019, and the group distributed €1bn by a special cash dividend on February 25 2019 and €300m – part of a €2.5bn share buyback plan – was completed in the first quarter of 2019.”

Dividend policy is an area of keen focus for the Pensions Regulator. In its 2019 Annual Funding Statement, the watchdog makes clear it wants to see “equitable treatment” between schemes and shareholders, and remains concerned about what it sees as the disparity between dividend growth and stable deficit-repair contributions. 

Where dividends and other shareholder distributions exceed deficit-reduction contributions, the regulator now expects a strong funding target and recovery plans to be short. For the weakest companies unable to support their scheme, it now expects the payment of shareholder distributions to have ceased.

However, Bob Scott, senior partner at LCP, notes: “The issue around dividends versus deficit contributions is more nuanced than some commentators suggest.

“Payment of dividends is a normal business function and, provided that the cash is available to pay the dividend and the pension fund is not being short-changed as a result, neither the regulator nor the government should have any concerns.”

The ICI scheme’s funding summary confirms that TPR has not used any of its formal powers to intervene with its valuation.

Few industry experts believe dividends should be put on hold until buyout is reached. At consultancy Aon’s Pensions Conference 2019, more than 800 attendees were asked for their view on what should happen to dividends where schemes are underfunded.

Thirty per cent thought dividends were fine and 55 per cent thought dividends should be allowed to increase gradually; only 7 per cent thought dividends should be put on hold until buyout funding was reached.

Regulatory scrutiny intensifies

If AkzoNobel has avoided any regulatory intervention over its dividend policy, other employers with less healthy scheme funding levels may not see the same outcome.

“Since the collapse of BHS and Carillion, TPR has become tougher and is intervening more in pension-funding negotiations; a particular focus is the size of dividend payments relative to deficit-repair contributions,” says Alistair Russell-Smith, partner and head of corporate DB at Hymans Robertson.

“Our analysis of DB pension schemes in the FTSE 350 estimated that 22 per cent could see regulatory intervention at their next triennial valuation unless they start to pay more into their scheme,” Mr Russell-Smith continues, adding that contingent funding and escrow accounts may help to avoid the risk of trapped surplus.

Graham McLean, head of pension scheme funding at Willis Towers Watson, agrees: “The regulator’s tone has been getting less and less conciliatory. We seem a world away from 2014, when parliament instructed TPR to ‘minimise any adverse impact on the sustainable growth of an employer’.

“Some schemes with strong employers, who thought they were sitting pretty before, can expect to find the regulator breathing down their necks and asking them to justify their approaches.”

Trustees must take balanced view

So how should trustees approach negotiations as part of their triennial valuation process? The appropriate level of contributions relative to dividends “depends on the specific circumstances”, according to Stewart Hastie, partner at KPMG, but trustees should try to be realistic in their assessment of the employer’s available cash.

Mr Hastie says: “What can sometimes get lost is the recognition that company directors, in determining how to allocate an organisation’s resources, need to balance the needs of a much wider range of stakeholders, not just pension schemes – for example, shareholders, debt providers, employees, customers, other group companies and future business investment opportunities.

“It may be appropriate for some companies to prioritise dividends – particularly if the scheme is very well funded, or the scheme has other forms of financial support and security.”

Jo Harris, trustee representative at Dalriada Trustees, says an equally important consideration is how the scheme’s funding needs might develop in the future. “It’s not unreasonable to distribute ‘surplus’ capital to shareholders. But, is today’s surplus capital tomorrow’s business investment or scheme funding? 

He adds: Trustees should consider the potential impact on the scheme of dividend payments, recognising the wider position and fundamentals of both the scheme and the covenant.”

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