Following research of UK defined benefit pension schemes with assets of over £1 billion, carried out by Barnett Waddingham, Andrew Vaughan, Partner at Barnett Waddingham, picks out some of the trends emerging from these schemes over the past year, and highlights some of the actions currently being taken by companies.
The UK’s largest defined benefit (DB) pension schemes are a fundamental part of the UK economy. Not only do they provide an important source of capital investment, they are also responsible for providing a retirement income for a large proportion of the population. Due to the vast resources available to these schemes, innovations often start with these schemes, before filtering down to the smaller DB pension schemes.
The decline of defined benefit
The increasing cost and risk of defined benefit pension provision has been well publicised, so it will come as no surprise that there has been an increase in the number of large schemes closed to the future accrual of benefits, up from 33% to 37%. While defined benefit pension schemes are highly valued by employees, more and more companies are recognising the unsustainability of these schemes and the substantial risk that they pose to companies. With most new employees being enrolled into defined contribution (DC) pension schemes, many companies are also struggling to justify the vast gulf in cost between defined benefit and defined contribution pension provision.
Liability management and risk reduction
The closure of a defined benefit pension scheme is the first step to containing the risk and cost of defined benefit pension provision. However, there still remains a large legacy pension liability for companies to manage. For this reason, many companies are now putting in place plans to ultimately settle their defined benefit liabilities. Barnett Waddingham’s research, into the largest schemes, provides some insight into the variety of techniques being employed by companies to achieve this.
The introduction of the pension flexibilities, in the 2014 Budget, significantly changed the opportunities available for companies to settle DB pension liabilities. For 10 of the very largest schemes with assets in excess of £10 billion, the median year-on-year increase in cash amounts transferred out was 80%. This highlights the attractiveness for members of being able to access their benefits immediately, and flexibly, once they reach the age 55. From a company perspective, members transferring their benefits can lead to an improvement in the scheme funding level, and the risk associated with providing the DB pension is entirely removed.
A number of schemes in our research have put in place a flexible retirement option (FRO), which provides members with the full range of options available to them in respect of their benefits, including the option to transfer away from the defined benefit pension scheme.
Investments and the PPF levy
A scheme’s investment strategy is an important decision, and one in which the company should take an active role. With many schemes closing to the future accrual of benefits, the timeframe for sorting out any deficit and investment issues is often much shorter than it was previously. The allocation of the large schemes’ investments to non-traditional asset classes, i.e. asset classes excluding equities, bonds, property or cash, increased from 23% to 28% last year. This likely reflects the increase in popularity of liability-driven investment strategies, as companies and trustees continue to take steps to reduce investment risk.
Another item on this year’s agenda for defined benefit pension schemes will be the PPF levy and, in particular, the upcoming changes expected to be made as part of the PPF’s three-yearly review. For the schemes that were analysed as part of our research, the average PPF levy was approximately £2.6 million last year, representing a very significant cost for companies. With numerous changes being proposed to the PPF’s assessment of insolvency risk this year, companies should ensure they are comfortable with the impact of these changes and, if necessary, seek professional advice to mitigate the size of any increase.
It will be interesting to see how the forthcoming Brexit negotiations will impact on the UK economy and legislative framework, and in turn what this will mean in terms of how the funding and investment strategies for DB schemes evolve over this decade and the next. Interest rates will undoubtedly continue to play an important role as will future longevity developments. Major legislative easements seem unlikely in the short term, which means many sponsors of DB plans will continue to face funding and investment challenges for some time to come.
More information on the research can be found here.