New research predicts that all defined benefit schemes of companies in the FTSE 350 index are likely to be closed to future benefit accrual within 10 years.
More than half (55 per cent) of DB schemes in the FTSE 350 have already been closed to future accrual, according to research by consultancy Hymans Robertson, which states that "future DB accrual within the FTSE 350 could switch off altogether within a decade".
I would be shocked if the employer hasn’t already at some point thought, ‘Why are we still offering this and do we still need to offer it?
Martin Hunter, Punter Southall
However, accounting deficits across FTSE 350 DB schemes have not consistently widened over the past 12 months. Research by consultancy Mercer showed that the accounting deficit of FTSE 350 DB schemes dropped to £134bn at May 31 2017, from £145bn at the end of April 2017.
In its paper, Hymans Robertson expressed concern over the Pensions Regulator’s push to increase annual deficit contributions as overly simplistic. It argued that this would create an incentive to take more investment risk to increase expected returns.
Selling assets to plug deficits
The report said that three-quarters of FTSE 350 DB schemes are currently cash-flow negative, up from 70 per cent last year.
John Walbaum, head of investment consultancy at Hymans Robertson, suggested that some DB schemes are becoming the victims of their own success as they struggle to meet their cash outflows without deficit contributions coming in.
“The schemes are maturing, they’re having to pay out more benefits, there’s going to be less money coming in – particularly if funding plans are successful and deficit contributions stop, they’ll get even more cash-flow negative. So the more successful we are, the harder this becomes,” he said.
“It’s a natural process, and it means that we need to now start planning how and when we sell our assets, to meet those cash flows in the future. The problem is that at the moment, we’ve still got deficits to fill, so we can’t afford to sell the assets,” he added.
Walbaum argued for the inclusion in portfolios of income-generating assets alongside assets with “a natural lifespan” that will mature and “throw off capital”, such as loans.
Derisking may increase the cost of accrual
The paper states: “The pressure to increase deficit contributions, combined with low yields pushing required contribution rates up to 40-50 per cent of pay, mean there will be more scheme closures.”
Martin Hunter, principal and actuary at Punter Southall, cited his experience of schemes with “a far lower cost of accrual, based on current market conditions, even with a fairly generous benefit structure”. He suggested the derisking of scheme investment strategies as a reason for an increase in the cost of accrual. Hunter saw no reason for schemes to be automatically "holding less risky assets like bonds, rather than equities”.
Hunter added that FTSE 350 employers who have retained their DB schemes may have done so under competitive pressures.
“If you’re a FTSE 350 company and you’re sponsoring a DB scheme which is still open to accrual, I would be shocked if the employer hasn’t already at some point thought, ‘Why are we still offering this and do we still need to offer it?” he said.
Dividends are set to come under scrutiny
The report advocates a longer investment timescale with lower contribution levels, arguing that this will raise the likelihood of members’ benefits being paid in full.
Scott Edmunds, investment consultant at Quantum Advisory, recognised Hymans Robertsons’ concerns that calling for increased contributions may lead to unintended consequences in the form of higher investment risk in DB scheme portfolios.
The heightened risk is coupled with the added financial burden of higher contributions. “With greater emphasis on larger contributions, the pension schemes are just becoming that bit more expensive for the sponsoring employer,” he said.
The cost of final salary pension schemes, while increasingly expensive, pales in comparison with FTSE 350 dividend payouts. The average company on the FTSE 350 pays dividends that are seven times higher than their pension deficit contributions, according to Hymans Robertson.
De La Rue cuts pension increases to ease funding pressures
Trustees of the De La Rue defined benefit pension scheme have agreed to cut inflation-proofing on member benefits, wiping an estimated £70m off the security specialist’s accounting deficit.
The regulator is expected to place additional scrutiny on companies that prioritise their dividend policy over their scheme funding obligations, if this is conducted during a recovery period or alongside high investment risk for a scheme.
“The idea that a company could have a struggling or significantly underfunded pension scheme, while at the same time that company returns large dividends… almost seems a little unfair,” said Edmunds.
