The largest occupational defined benefits (DB) pension schemes, with assets over £1bn, are an integral part of the UK economy.
These schemes invest substantial amounts of capital in the wider economy and are responsible for the retirement wellbeing of a large proportion of the population. They also strongly influence the behaviour of smaller schemes, for example with respect to developing innovative methods of sponsor support and risk mitigation. Following research of these schemes, carried out by Barnett Waddingham, Andrew Vaughan, pictured, 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.
Employer deficit contributions
Employer deficit contributions can represent a significant cost to a company, with the increasingly large scheme deficits seen in recent years leading to higher levels of contributions due. For those companies in our survey paying deficit contributions, the mean annual deficit contribution was around £208 million. There were 12 schemes that received deficit contributions of at least £100 million, and the largest level of contributions received amounted to over £4 billion.
In some cases, companies may be facing affordability issues with the level of contributions due. There can also be implications on the payment of dividends to shareholders, with the Pensions Regulator indicating in its latest Annual Funding Statement that it will be paying increased attention to the level of dividends paid to shareholders versus the level of deficit contributions paid to the pension scheme.
In view of this, many companies will be interested in ways they can reduce their contribution requirements, which could include negotiating funding assumptions and recovery plans with the trustees, or undertaking liability management exercises.
Transfer value activity
The advent of Freedom and Choice in the defined contribution (DC) landscape could have a substantial impact on DB scheme liabilities. Under the new legislation, members over the age of 55 are able to access their DC benefits in a variety of ways, including purchasing an annuity, accessing drawdown, or taking some or all of their pension pot as a cash lump sum.
Members of DB schemes can also access the new flexibilities, provided they first transfer to a suitable DC arrangement. It is therefore hardly surprising that many schemes are seeing an increase in requests for transfer value quotations. The new freedoms may also make liability management options, such as enhanced transfer values, more attractive to members.
Most schemes in our survey experienced a year-on-year increase in transfer value amounts paid. The median increase was 56%, although some schemes saw an increase of over 200%.
However, the new freedoms also bring their own challenges. For example, many schemes are now seeing an increase in the volume of transfer value requests, as members explore their various options as they approach retirement. This in turn is leading to a significant increase in administration expenses for some schemes. In other cases, members have reported having difficulty finding IFAs who are prepared to advise on transfer values, and are therefore unable to obtain the financial advice needed for a transfer to proceed.
With major changes to the levy determination coming into effect this year, PPF levies remain a topical issue. The PPF aims to collect £550 million in levies for the 2018/19 levy year, which is around 10% less than the £615 million collected for the 2017/18 year. However, according to the PPF’s own research, some larger schemes are likely to see an increase in their levy.
For the schemes in our survey, the average PPF levy paid was around £2.6 million, which represents a significant cost to companies.
For pension schemes of the size in this survey, material savings may be made by engaging in professional advice to mitigate the size of the levy. Some possibilities include submitting a certificate of deficit reduction contributions, or certifying a contingent asset, such as a company guarantee, to improve the insolvency risk.
The decline of defined benefit and the future of UK pensions
Volatile investment returns, increasing life expectancy, increasing levels of ongoing expenses and increasing amounts of government legislation have all contributed to the increasing cost of DB schemes in the UK. It is therefore hardly surprising that many employers have closed their DB schemes and enrolled their employees into DC schemes.
This trend is backed by our survey, which shows that the proportion of schemes closed to the future accrual of benefits stands at 43%, up from 37% last year. Only 4% of schemes are still open to new members.
However, there is a general concern that due to insufficient rates of contributions, poor investment returns and high levels of management expenses, many members will not receive adequate retirement income from their DC benefits, and may end up relying on the State for support in retirement.
Our report considers in more detail what the future of pensions in the UK might look like, and whether there may be scope for a third way between DB and DC – ‘defined ambition’. We will await with interest to see how this develops in future years.