Over the last decade it has become well-established that pensions – especially Defined Benefit pensions – cost a lot and are high risk for companies.
We’ve become so used to hearing phrases such as “British Firms Burdened with Pensions deficits”, “DB pensions costs surge to a new high” or even “Pensions risk makes companies as risky as hedge funds” that they have almost become clichés.
If you cast your mind far enough back there was a time when things weren’t quite so bad – when assets were on the up, we didn’t think that over half the population would live until their 90s and companies even occasionally went on a ‘contribution holiday’ – remember those? Perhaps not.
Ok so we’re not quite there yet – you can keep your passport (of whatever colour) in your drawer for now. However the recently released Buck Mid Market Pensions Review 2019 indicates that – as sung by old Poppa in the classic musical Starlight Express – there may just be a light at the end of the tunnel.
For once we are actually seeing pension funding positions improve – by c. 7% over 2017 and 2018, depending on the measure used.
One key reason for this is trends in life expectancy, giving around a 1 year reduction in life expectancy at age 60. This is now widely thought to be an established long-term trend, rather than the result of short-term factors (e.g. cold winters). It is slightly odd to think of this as good news – it is clearly quite the opposite from individual people’s perspective – but it provides a boost to pension schemes’ financial position, in some cases giving a sizable improvement of 5% or more.
The improvement in funding position is providing a platform for greater innovation in scheme investments, with a further swing away from traditional classes like equities. Approaches such as Liability Driven Investment are becoming more commonplace across the mid-market, driven by the attraction of maintaining a good level of return but at a reduced level of risk. These strategies can also help schemes address their increasing cash flow needs, with 3 in every 4 schemes now paying out more money than they are receiving in contributions according to our review.
Furthermore, pricing for insurance ‘buy-ins’ has also become keener of late – in part due to lower life expectancy. A greater number and range of schemes are taking this opportunity to reduce risk by introducing a buy-in to their overall strategy.
Innovation is also rife in pension scheme design. Will the proposed introduction of a Collective Defined Contribution scheme by Royal Mail signal the start of a move back towards risk-sharing arrangements? Will the Government’s consultation on DB scheme consultation yield any workable and widely applicable solutions on how to manage legacy DB schemes efficiently? The introduction of new flexibility like this increases the range of levers that companies are able to pull to manage their pensions costs and risks, and also ultimately has benefits for member outcomes. There are signs that companies are breaking new ground with their employee benefit strategies – looking at how they can cast the net wider than traditional pension schemes to get the most out of their employee benefit budget, with the ultimate objectives to both maximise employees’ financial wellbeing and aid long-term workforce planning.
Just as companies appreciate flexibility, it is clear that members do too – as evidenced by an increase in pensions transfer activity. Transfers can be ‘win win’ – in that they improve schemes’ financial position while being a beneficial option for many members – but they carry some risk if not done properly. A larger number of companies are taking control of this and either running a high quality one-off engagement exercise, or at least looking to work with Trustees to improve the support provided to members, thereby smoothing the path to a successful transfer.
Now I realise I’ve been very positive so far, but I should acknowledge three potential flies in the ointment…
Firstly, the Government is talking tough on reckless behaviour on pensions; companies should take action, yes, but do so carefully and based on sound advice. The latest funding statement from The Pensions Regulator signals they will make a nuisance of themselves if, for example, they think companies are prioritising shareholder dividends over pension contributions.
Secondly, GMP equalisation is set to impact up to around 5 million people. This will result in an increase to liability values and running costs, unless action is taken to make sure the process runs smoothly and any associated opportunities to reduce costs are maximised.
Thirdly, Brexit is still looming large, with all the uncertainty that brings for the coming years.
But this is an up-beat blog so we end on a high note, as delivered by Poppa in that great opus of Andrew Lloyd Webber: the inside might be as black as the night, but at the end of the tunnel there’s a light. Starlight!
The Buck Mid-Market Pensions Review 2019 covers around 1,900 defined benefit pension schemes in the range £10m to £1bn in asset size, sponsored by UK companies. Take a look at the review report below.