By Nick Griggs, Partner & Head of Corporate Consulting, Barnett Waddingham
To give an idea of the scale of FTSE350 companies’ DB pension commitment, around £20 billion of pensions are expected to be paid out of these schemes next year. This compares to the government’s annual state pension commitment of around £90 billion. Big business often gets some bad press, but this highlights the important support that they provide to their former employees in their retirement.
There is often disbelief at the volatility and continual growth of the DB deficit figures during a period when scheme assets have generally performed well. It might help you to understand that the DB pension arrangements of FTSE350 companies are expected to pay out over £1.4 trillion of benefit payments over the next 60 years or so. These companies currently hold around £630 billion of DB pension scheme assets, which are intended to meet these obligations.
Closing the gap
While investment returns will go a long way towards closing this gap, there is no doubt that contributions from employers will also need to play a significant part in ensuring that these benefits for former employees are paid in full. The talk of increased deficits and the need for companies to pay more can almost entirely be attributed to the fact that future investment returns on the £630 billion of assets held are likely to be lower than we were expecting only a few years ago.
Employers are already feeling the strain of meeting DB pension costs, with around 30% of the companies in this survey relying upon external sources of finance or drawing on their cash reserves in order to finance deficit recovery contributions. From The Pensions Regulator’s point of view, however, increased deficit contributions look very affordable to companies, given the level of dividends being paid at this point in the economic cycle.
The true picture, though, is rarely that straightforward. Contributions to reduce DB pension deficits have remained reasonably stable in recent years (at an aggregate level of around £8 billion), and are significantly lower than the level of contributions seen in the years immediately after the financial crisis. However, with renewed uncertainty in the UK after the EU referendum and with gilt yields continuing on a downward trend, it is presumably only a matter of time before we see another upwards movement in deficit recovery contributions. How much flexibility employers are given in extending recovery plans will be an area of massive debate over the next few years.
Moving from DB to DC
The move from DB to defined contribution (DC) schemes for current employees has been well-publicised. However, despite the closure of the majority of DB schemes to current employees, around a third (34p out of every £1) of money spent by these companies on pension provision in 2015 was directed to plug deficits in DB schemes. This is staggering given that many DB scheme members will no longer be employed by the pension scheme sponsor, and highlights the generational divide that exists in terms of pension prosperity. This is an emotive political and social issue with no obvious answers, but the notion of intergenerational fairness is very much on the public agenda with the Work and Pensions Committee having launched an inquiry on the topic in 2016.
With potentially stronger protections coming for DB schemes in light of BHS’s failure, and no end in sight of the difficult financial conditions they face, there is certainly far more debate to be had on this topic in the coming years.
To read the full report, please click here
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