The end is nigh for DB pensions

When I left the country, closures to new entrants in defined benefit schemes had been popular, but by the time I got back the trend to close to accrual was noticeable. Those of us specialising in DB schemes had a feeling that the end of such schemes was coming, and that our career choice may not see us through to retirement.

Individuals and companies have been waiting for this day for years. I think it is finally arriving

In the almost 20 years since then we seemed no closer to securing DB benefits, but looking around this year I think we have reached a tipping point.

The first reason for this is funding. Earlier this year I spoke at the Aon conference about the challenges of being fully funded. 

It is a topic that would have been laughed at just a few years ago, but with around 30 per cent of schemes advised by Aon now fully funded on a technical provisions basis (and more getting very close) this is increasingly the reality trustees are facing. 

The challenges of a scheme being fully funded are not on the same scale as having a huge deficit the company cannot afford to fill, but there are challenges nevertheless on the journey to a pension fund’s long-term funding target.

Buyout costs decreasing

The second reason relates to maturity. Schemes have always been maturing, but it is now making a real difference to the possibility of securing benefits. 

Specifically, the cost of buyout is rapidly reducing to levels that look affordable. In fact, with expected returns reducing and deficit contributions stopping, the way to reach buyout is no longer dominated by schemes increasing their assets towards buyout, but as much by waiting for buyout pricing to fall towards their assets.

The reason for this is two-fold. First, more members are reaching retirement, and as benefits come into payment and the uncertainty around tax-free cash is resolved, pricing improves. Many schemes now have more liability as pensions in payment than deferred members.

Second, the deferred members are getting older, and insuring a deferred population with an average age of 60 is far more cost-effective than an average age of 50. The combined effect of these factors can mean that buyout pricing is heading towards you at about 1 per cent a year.

A shrinking market

The third reason we have reached a tipping point relates to size. Pension plans are shrinking, both in absolute terms and real terms. 

While some schemes still have positive cashflow at an asset level, at a liability level the flow is almost all one way, with pensions, lump sums and transfer values all reducing the size of schemes. 

A scheme with £500m of liabilities today can expect to have around £400m of liabilities in 10 years' time, and adjusted for inflation that is equivalent to around £300m in today's money.

The DB market size is also shrinking at an overall level, as buy-ins, buyouts and transfers-out now easily exceed the accrual of future benefits.

The combination of these three funding, maturity and size factors is far-reaching.

The wall of money heading towards buyout will increase rapidly. So far, we have seen just the first few per cent of benefits being secured. This is equivalent to the first 1,000 runners in the London Marathon, with finishing times well under three hours. What happens as the other 39,000 start to arrive?

Supply from reinsurers may enable insurers to take on more longevity risk, and we expect growth in the availability of the assets insurers need. But it is hard to predict which way this will drive pricing overall.

Moreover, as the money heads towards buyout it will leave the traditional industry. Investment managers and consultants, actuaries, lawyers and administrators will all have substantial work in the short term, but not in the long term. Individuals and companies have been waiting for this day for years; I think it is finally arriving.

Finally, the DB pensions industry itself may need to shrink. We are already seeing consolidation of schemes and advisers. But we still have a multitude of industry bodies, magazines, websites and industry experts. There also many conferences, seminars, webinars, podcasts, dinners and award ceremonies.

The focus will continue to change as defined contribution schemes (and hopefully collective DC schemes) grow. But for the DB industry, consolidation is inevitable.

Paul McGlone is president of the Society of Pension Professionals and a partner at Aon