Is your final salary pension at risk?

Three million final salary pension savers have just 50 per cent chance of receiving their benefits in full, a new report by the Pensions and Lifetime Savings Association (PLSA) has warned.

According to the PLSA report, the majority of final salary or defined benefit (DB) pension schemes, which have 11 million members in the UK, look sustainable despite the fact that the overall deficit for final salary schemes has stood at over £400 billion for the past decade.

But for the weakest schemes, ‘millions of people’s retirement incomes are now at risk’, due to a combination of factors: increases in life expectancy, record low interest rates and lower investment returns.

Deficits remain at sky-high levels despite the fact that employers have dug deep into their corporate pockets, allocating £120 billion over the past decade in a bid to reduce deficits - known as deficit recovery contributions (DRCs).  

-How to transfer out of a final salary pension 

The PLSA says this is proof that ‘doing nothing is not an option,’ and has called on the creation of ‘superfunds’, which would provide a means for struggling employers to consolidate their pension schemes and reduce their liabilities.

The report adds: ‘Millions of people’s retirement incomes are now at risk with approximately three million people in DB schemes having only a 50 per cent chance of seeing their benefits paid in full, despite the fact that employers are paying out billions each year in DRCs.

‘Indeed, for some employers the cost and uncertainty of these DRCs will further jeopardise their future, diverting money away from crucial investment in developing their businesses and improving the productivity of their workforce.’  

According to the report, modelling and analysis by the PLSA provisionally indicates that superfunds could pay members the full value of their benefits in more than 90 per cent of scenarios. Further, it adds that by pooling pension schemes together there would be the ‘potential to improve outcomes for more than three million members’.

-How to transfer out of a final salary pension

It adds: ‘Transferring to a “superfund” could allow employers to concentrate on securing the future of their business, provide trustees with another way of securing member benefits, and ensure members gain from the greater likelihood of their benefits being paid in full.’

On the surface the superfund proposals are arguably quite radical, but were welcomed by Calum Cooper, head of trustee consulting at Hymans Robertson. According to Cooper for smaller schemes with stressed sponsors the ability to take advantage of economies of scale will reduce costs and would potentially deliver better outcomes for pension savers.

‘For employers with shaky covenants that are less likely to be able to pay benefits in full, being able to transfer to a consolidated vehicle with an immediate capital injection from third party investors, with appropriate regulatory protection, could clearly improve outcomes for members,’ says Cooper.

But Kate Smith, head of pensions at Aegon, cautions that ‘giving employers an option to walk away from their DB schemes creates a moral hazard’, so therefore the proposal needs to be ‘treated very carefully by government and regulators alike’.

She adds: ‘Cutting the cord between a pension fund and its sponsoring employer also removes DB schemes’ financial back-up plan, and could weaken members’ bargaining position should the superfund run into trouble. It’s absolutely critical that the funding and solvency of any superfund is both robust and supported with clear rules on who would make up any shortfalls to ensure trust and confidence in pensions.'

The superfund proposal comes on the back of a big spike in the number of pension savers transferring their final salary pensions over the past 18 months or so, as transfer values have hit record levels.

Transfer values have risen so dramatically because yields from bonds – in which final salary and defined benefit pensions are mainly invested – have fallen to record lows. Low bond yields increase the cost to pension schemes, as they need larger funds to produce the same income, which is why they are keen to reduce their liabilities and get pension savers with financial salary pensions off their books.

-The pros and cons of cashing in a final salary pension

The attractions of transfers have also been boosted by rule changes allowing cash to be taken from a pension from age 55 and residual funds to be bequeathed on death.

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