But members of DB pension schemes should not rush for the exit

Key points:

• Encouraging a mass of transfers would be wrong for the majority of DB scheme members and worsen the funding position further for many schemes
• The impact of low yields won’t be felt equally by all schemes – it depends on the interest rate hedges they had in place
• More schemes closing to new entrants is inevitable, as the cost of providing a DB pension has now risen to 50% of pay

The combined deficit of UK Defined Benefit (DB) schemes has hit £1 trillion, according to Hymans Robertson’s 3DAnalytics, which provides real-time updates to the funding positions of Defined Benefit pension schemes.

The deficit figure has breached this level due to further falls in gilt yields as the Government’s quantitative easing programme hits unanticipated stumbling blocks. Ultra loose monetary policy and wider economic factors mean pension schemes are more likely than ever to want to hold on to longer-dated government bonds.

Explaining why investors are reluctant to give up longer-dated gilts, Patrick Bloomfield, Partner at Hymans Robertson said:

“The Bank of England’s reduction in the base rate actually increased demand for gilts, making it less likely that investors will sell to the central bank. Every time the Monetary Policy Committee reduces the base rate, it pushes up DB deficits, and that puts even more pressure on trustees to hedge risk. The most impactful way they can do this is through gilt based investments.”

Discussing what this means for the current inquiry into the sustainability of DB schemes, he added:

“The sustainability of DB schemes had come under the spotlight due to difficulties faced by several recent high profile schemes, such as Tata Steel and BHS. But we need to caution those in DB schemes against a rush to the exit, despite the allure of so called “Freedom & Choice”. Transfer values are at record highs, but once a DB member transfers out, there’s no going back. Finding a better deal elsewhere might not be possible for the majority, without taking on more personal risk.

“However for members considering whether to transfer, there are now technology solutions available to help them to make an informed decision, whilst also helping trustees to fulfil their duty of protecting members’ interests.  If pension schemes experience a lot of members trying to transfer their pensions out, trustees are likely to use their powers to reduce transfer values to protect their scheme’s funding for those who remain.

“Schemes with substantial interest rate hedging, while taking a slight hit, are generally doing okay. Those with no or low interest rate hedging in place will have been hit very hard over the last few weeks. It’s hard for an individual to find out which camp their scheme is in, but this is the kind of research consumers need to undertake.

“A key question is whether there is a strong business standing behind the scheme or not. Pension schemes can weather this storm if they can rely on strong business support. Only members in schemes with less robust sponsoring businesses need to be worried. But in the current economic climate it’s unlikely we’ll see a sudden rush of more schemes falling into the PPF. We need to remember that corporate failures in the UK continue to be low, with underperforming businesses propped up by low interest rates and cheap borrowing.

“One consequence of this QE-led pain for pension schemes is a final push of businesses withdrawing DB benefit for the few staff who have been lucky enough to still enjoy them.  Every week there is a new story in the press demonstrating the fresh round of scheme closures we are in the midst of. Higher costs from the end of contracting-out was a catalyst for many businesses and the unintended consequences of QE have caused DB costs to spike over 50% of pay for many schemes, which simply isn’t sustainable.”