As the government tries to allay fears over funding levels for final salary pension schemes, can it do more to help companies limit their liabilities, asks Jane Fuller
This article was first published in the April 2017 UK edition of Accounting and Business magazine.
The funding hole in the UK’s defined benefit (DB) (linked to final salary) pension schemes has acquired crisis status over the past couple of years. Longer life expectancy combined with a lower discount rate for liabilities sent the total deficit in nearly 6,000 company-backed schemes to £459bn last August.
Yet the news has been better this year. The Pension Protection Fund’s PPF 7800 Index showed a reduced deficit of £196.5bn at the end of January. Peace has broken out in two high-profile cases: both the British Steel and BHS pension schemes look set to be separated from their distressed corporate backers, continuing instead as standalone funds with modified obligations.
To cap it all, the UK government’s Department for Work and Pensions (DWP) declared in a green paper published in February (Security and Sustainability in Defined Benefit Pension Schemes): ‘The available evidence does not appear to support the view that these pensions are generally “unaffordable” for employers.’
Its ‘don’t panic’ message suggests that funding levels are set to improve significantly by 2030 and that only one in 20 schemes has serious affordability issues. Not surprisingly, other estimates – such as from the DB Taskforce set up by the Pensions and Lifetime Savings Association (PLSA) – are more pessimistic.
But even the more emollient view contains little of substance to reassure companies, which have been paying well over £30bn a year into DB schemes.
The DWP cheerfully expects the high level of contributions to continue. It compares ‘deficit repair contributions’ (DRCs) (additional to regular payments into schemes by employers) with pre-tax profits. For a quarter of the companies, DRCs were more than 50% of profits in 2015. How affordable is that?
The suspicion remains that money that might otherwise have been used for corporate investment has gone into pension schemes, which, by the way, have increasingly invested their funds in government bonds rather than equities. To the small extent that DB funds do invest in UK equities, the DWP analysis is far from encouraging. It trumpets that FTSE 100 companies paid five times as much in dividends as they did in DB contributions in 2015. The implication is simple: switch some money from dividends to the pension fund. This will reinforce the trend towards risk-averse investment.
Is there any hope that government action might help limit liabilities? After all, even the lauded Dutch system allows benefits to be cut if schemes are under financial pressure. Judging by the fuss over the idea that inflation protection should be trimmed, by linking it to the consumer price (rather than the retail price) index, the answer is no. While more schemes are likely to be sloughed off into entities that pay less, this will only be available to companies having a near-death experience.
Unless, that is, it can be done by consolidation. Reducing thousands of schemes to a few hundred might deliver not only economies of scale but also rationalisation of benefits. What stick might induce members of DB schemes to ‘volunteer’ for this? A survey for the PLSA showed that 71% did not realise that promised pensions depended on the solvency of their (often ex) employer. Asked a different question, 62% said they would prefer a lower level of retirement income if it could be guaranteed.
The high-profile British Steel and BHS stories are just amplified versions of the trade-offs that will be faced by more of the 11 million members of DB schemes.
Jane Fuller is a fellow of CFA UK and serves on the Audit and Assurance Council of the Financial Reporting Council