Government too complacent on final salary schemes
27 September 2017
- Three million pension scheme members have no more than 50/50 chance of getting their pensions
- ‘Superfunds’ could ease pension pressures before more employers become insolvent
- As Brexit economic and political uncertainty worsens, final salary pensions are more at risk
No room for complacency as closed schemes will need better ways to manage liabilities: Britain’s Defined Benefit (DB) final-salary type pension schemes are under unprecedented pressure. So far, the Government has been rather complacent about the risks, but with the ongoing ultra-low interest rate environment and rising economic and political uncertainty, new thinking is urgently needed.
Millions of members at risk: The PPF estimates 3 million people have no more than a 50% chance of getting their promised benefits, while three quarters of sponsors are facing significant challenges in running their schemes.
Deficits have stuck at £400bn for past ten years, despite £120bn employer contributions: Despite ploughing £120billion into DB schemes to improve funding, the aggregate DB deficits have stayed around £400billion for the past ten years. Employers have been running to stand still and the hoped-for funding improvements have generally remained elusive.
As most schemes are closed, sponsors will soon be desperate to get rid of legacy liabilities: With the majority of schemes now closed, within the next 5-10 years, these sponsors will have no interest in or worker connection with the scheme. 90% of FTSE350 schemes are expected to become cash-flow negative in the next 5 years. Sponsors will look for ways to get rid of this legacy risk, or will go bust, especially if the economy weakens. The Government must plan ahead for this now.
Not enough flexibility – making the best the enemy of the good: Many companies would like to honour their obligations, but in an affordable way. However, the options for employers and members are binary. Employers who can continue in business, must purchase annuities for full benefits before severing links to the scheme. This is prohibitively expensive, especially in the current interest rate environment and it is questionable whether excessively expensive annuitisation is a sensible use of corporate resources.
Pensions can’t be reduced unless sponsor going bust: Quite rightly, employers cannot walk away from their schemes. But once employers are facing inevitable insolvency, benefits are reduced by around 10-20% in the PPF. There is no flexibility for companies which struggle on in business.
BHS and Tata may provide a blueprint for companies which are managing to keep afloat to ‘wind-down’ rather than having to ‘wind-up’: BHS and Tata schemes, however, have been allowed a different option. Their trustees are running their schemes with the aim of paying benefits better than PPF, based on assumed prudent future investment returns, without annuitising. BHS and Tata sponsors paid a premium over the expected future cost of the promised pensions and trustees will aim to deliver promised benefits over time. Using this as a precedent, one can suggest a new option to allow employers to meet their obligations at more affordable costs, without insolvency and without annuities. This is rather like allowing the schemes to wind-down, rather than winding-up and be a model for other schemes.
‘Superfunds’ could help with consolidation: PLSA proposals for ‘Superfunds’ could be helpful in achieving this aim, because pooling schemes will allow reduced costs of delivering the pensions. And allowing employers to rely on future investment returns as well, rather than annuitising, will help remove pension risk from their balance sheet and free them to focus more resources on their business, or improving pension contributions for other workers.
Members have better chance of receiving higher pensions: By offering sponsors a viable alternative to unaffordable buyout, members would have better chances of receiving full benefits, rather than reduced PPF pensions. The idea would be that employers must pay in enough money to meet expected future pension payments, with assumed investment returns over time, plus a capital buffer (perhaps an extra 5-10%). This would be much less than the cost of buyout but would still be expected to deliver full pensions to all members.
Pooling can reduce costs and improve expected investment returns: By joining thousands of small pension schemes together into much larger Superfunds, administration costs would fall. The Regulator estimates average per member costs of administration and advice for schemes with over 5000 members is £87, while for schemes with under 100 members it is £653. Superfunds should also improve investment returns, risk management and governance. Large pools of assets can achieve better diversification and access higher quality fund management, with a larger and broader spread of asset classes.
Superfunds could benefit the economy as more assets invest in infrastructure or social housing: Not only could Superfunds reduce costs of administration, external advisers, legal and accountancy fees, but they would also allow more pension assets to be used to fund infrastructure, social housing or other long-term much needed investments.
Employers could raise one-off loans to pay the pension debt and avoid future profit drain: The employer could perhaps take out a loan to meet the required additional funding of the consolidation scheme, cleaning up its balance sheet and without the same drain on future profits because the debt would be a one-off capital transaction. Once the extra funds were put in, the employer would have no residual liability for members’ pensions.
Standardising benefits could halve admin costs: In order to achieve the necessary cost reductions, it would certainly also help to standardise and simplify benefits. It is estimated that administration costs could be reduced by over 50% if benefits were streamlined.
Win-win for members, employers, economy and younger generations: Such a reform would be a win-win for employers (who can get rid of pension risk more affordably), for members (who would have more chance of getting full pensions) and for the economy (as more money could invest in public or higher return projects) and for younger generations (if employers have more resources to devote to their pensions, rather than buying out members of closed schemes).