ANYONE lucky enough to be a member of a final salary pension scheme should have few worries about how to fund their retirement, with the reward for years of loyal service being a guaranteed income for the rest of their life.
As the cases of BHS and Tata Steel show, however, a scheme is only as good as the employer who funds it, with the former going into administration at a time when its pension scheme needed £571 million to be able to pay all the pensions it is liable for, while the question of what to do with the latter’s £15 billion pension fund, which is also in deficit, is hampering the rescue of the ailing employer.
With the total shortfall across the UK’s 6,000 final salary schemes sitting at £710bn at the end of August, according to research from accountancy giant PricewaterhouseCoopers, it is understandable that many current and prospective pensioners may be worried they won’t get what they are due.
However, according to Jamie Jenkins, head of pensions strategy at Standard Life, there is no immediate need for people to panic because “it’s very common for schemes to be in deficit”.
“On the face of it the deficit means they don’t have sufficient assets or investments to cover the promises they have made to members to pay pensions, but that’s pretty common and many employers have plans in place to make sure they have sufficient money for the long term,” he said.
Irn-Bru maker AG Barr, for example, transferred its Cumbernauld headquarters to its pension fund in 2013 to boost its assets and has been paying the scheme £1.1m a year in rent since. More recently, it agreed a bulk annuity deal with Canada Life that will see the insurer rather than the scheme take responsibility for paying the pensions of half its members.
While many others have taken similar action, Carol Ann Mitchell, a chartered financial planner at Executive Benefit Consultancy, noted there is no obligation on employers to “immediately extinguish the deficit by making a large contribution”, with the question of whether a scheme is in deficit or not being calculated on a triennial basis.
Every three years the value of the assets a scheme holds as well as what it is likely to have to pay out in pensions to members is worked out. If the value of the assets is greater than the amount to be paid in pensions the scheme is said to be in surplus but if it is lower it is said to be in deficit.
The problem is both figures are a moveable feast, with Ms Mitchell noting the total pensions payable figure is calculated based on “future assumptions” – such as guesses about when people are likely to die – while Mr Jenkins pointed out the value of a scheme’s assets can vary greatly depending on market conditions.
Mr Jenkins added that so many schemes have been reporting deficits in recent months “because of the strange position the markets have found themselves in”.
“Interest rates were at historically low levels but have reduced even further and that has a knock-on effect on a lot of the assets pension funds invest in, such as government bonds, because it reduces the return they make,” he said.
The Bank of England’s decision to lower interest rates to 0.25 per cent aside, one of the biggest influences on the “strange” markets in recent months has been the UK’s decision to pull out of the European Union. But while that has been bad news for some pension schemes, for others the impact has been positive.
Juliet Bayne, head of pensions at Edinburgh law firm Brodies, said: “There’s a bit of a tendency at times to blame Brexit and bond yields definitely dropped significantly after the vote, but they had been low before that for a while anyway. The funny thing about Brexit is you have falling yields but because the pound is so weak all the schemes invested in equities abroad are doing very well.”
Alan Baker, head of DB risk at consultancy Mercer, agreed, noting that “schemes will hedge a bit of currency risk and those that reduced the hedging in the run-up to the Brexit vote will have benefited from the currency drops”.
Despite the fact such factors can have a marked influence on how schemes are valued, with some passing from a deficit to surplus between one valuation and the next, there is still a small risk that a minority of companies, of which BHS is one, may not ultimately be able to meet their obligations to their pensioners.
Even in this eventuality members are unlikely to be left high and dry, with the Pension Protection Fund (PPF), which is funded by levies paid by all final salary schemes, able to step in and pay existing pensioners as normal.
For those yet to retire 90 per cent of what they would have received will still be paid by the PPF.
Essentially, the message is clear: rising pension deficits may be another mark of a troubled economic climate but for future and existing final salary pensioners they shouldn’t create too much of a headache.
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