Talk of an affordability crisis among UK defined benefit (DB) schemes is not borne out by data, the executive director for regulatory policy at The Pensions Regulator has said.
Writing in a blog post last week, Andrew Warwick-Thompson said alarming media coverage was giving the impression DB pension fund deficits were in crisis, unaffordable and “about to rain Armageddon on UK Plc”, with cuts to member pensions being the only way to avoid widespread insolvencies.
He said this was misleading, based on deficits calculated on a buyout basis – reflecting exceptionally low bond yields and the cost of capital buffers and a profit margin for insurance companies – rather than a “scheme-specific basis”.
Very few schemes fund themselves on a buyout basis, said Warwick-Thompson, so the £1trn-1.5trn (€1.1trn-1.7trn) deficit figure quoted in media headlines is “really of academic interest to the majority of schemes”.
The scheme-specific basis for calculating deficits, according to Warwick-Thompson, “allows schemes to carry out their valuations in a way that reflects the anticipated returns on the investments they actually hold now and anticipate holding as their investment strategy matures”.
He said a pension scheme did not have to invest only in bonds but had “great flexibility” to diversify by investing in asset classes such as equities, property, infrastructure “and even derivatives”.
“As the returns on these assets are generally anticipated to be higher than the yields on bonds, the discount rate used to calculate the scheme-specific deficit will be higher, too, and the deficit correspondingly lower,” he said.
Overall, he said, even though there are some sponsors that may become insolvent and their schemes end up with the Pension Protection Fund (PPF), this is a minority, and there is no evidence the PPF would be overwhelmed by this.
“In summary, the real scheme data doesn’t show there is a systemic DB affordability issue,” said Warwick-Thompson.
“The majority of employers will be able to ensure their DB schemes are sufficiently funded to meet their liabilities as they fall due.”
His comments came only days before consultancy JLT Employee Benefits published fresh figures on the funding position of UK private-sector DB schemes, which it said would lead to questions being raised about the affordability of pension liabilities.
The consultancy recently published its monthly index of the estimated funding position of UK private-sector DB schemes, according to which deficits stood at £503bn as at 30 September.
This is equivalent to a funding level of 74% and represents a slight improvement from the situation at the end of August.
Charles Cowling, director at JLT Employee Benefits, said “[t]here seems to be no relief in sight, however, for companies with large pension schemes and their pressed trustees”, pointing to expectations that Gilt yields would remain below 1.5% per annum for the next 20 years.
“The government and regulators are facing some troublesome choices,” he said.
Cutting pension benefits to members or reducing guarantees will be unpopular with voters, but forcing companies to guarantee pension promises made when market conditions were different could lead to dividends being scrapped, share prices falling and, “worse still, companies going bust”.
Cowling added: “Changing how pension liabilities are valued, as some have demanded, does nothing to help the problem – it just sweeps it under the carpet for someone else to manage.”