Mind the (DB funding) gap
08 Jun 2016 - Estimated reading time: 60 seconds
DB pension schemes have long been a worry for the businesses that sponsor them. Despite £500bn having been pumped into pension schemes since 2000, the overall deficit has still tripled to circa £800bn. The cost of paying pension commitments has become far more onerous than anyone ever envisaged.
The situation only seems to be getting worse. BHS’s recent collapse and Tata Steel’s unwieldy pension deficit put the issue into stark context. And despite trying to plug the funding gap, it’s highly likely that this year’s triennial valuations will reveal further nasty surprises for many.
Our recent research revealed that one in seven CFOs consider their DB scheme to be one of the biggest risks to their business this year. The Pensions Policy Institute corroborate our findings. Their December 2015 research indicates that around 1,000 businesses (sponsoring around one in six DB schemes) are expected to become insolvent as a result of their DB liabilities. It is no surprise that CFOs are concerned.
The Tata steel example shows the creative “solutions” out there. But it’s an extreme one in this case. It reminds me of the old joke about the surgeon who proclaimed that his surgery had been a great success. When asked how the patient was, the answer was “dead”. While not quite so extreme, a proposed change to link pension increases to a lower rate of inflation, will significantly reduce the fund liabilities (we estimate by £2.5bn). This turns a £700million deficit to a surplus, but requires a change in law. The result of the Government consultation could mean a happier ending for Tata’s scheme members compared to entering the PPF now. It is worth remembering that the improvement to funding only comes about through paying scheme members lower pensions. It is also not yet clear who would take responsibility for this scheme in future, should deficits remerge over time.
It’s highly likely that this year’s triennial valuations will reveal further nasty surprises for many...
CFOs can work to formulate a clear strategy for dealing with the complex issue of legacy pension liabilities. However, when we surveyed CFOs 18% said they don’t know their end goal for their DB scheme and 35% don’t have a target timeframe to achieve their goal. In our 2015 Trustee Barometer almost half of trustees hadn’t determined a timeframe for reaching their goal despite 88% saying they had a measurable strategy in place.
It seems there is ample opportunity for trustees and CFOs to collaborate more. After all, their objectives may differ but ultimately they have the same goal: to run a pension scheme that remains affordable for the business that sponsors it, whilst ensuring its members receive their benefits.
So how can CFOs and Trustees work better together? We think there are three things needed to get schemes on track:
- Purpose: clear long-term objectives and a measurable strategy
- Precision: accurate, up to date, on demand management information
- Pace: taking no more risk than required.
There are no short-term fixes to plugging the DB funding gap. But by working in this way we’re sure CFOs and trustees will be able to achieve more resilient pension schemes. For CFOs this means less likelihood of requests for higher cash contributions. Trustees get greater security of being able to deliver members’ benefits in full. Ultimately, pensioners get the happy ending they deserve.
You can find more insights from our CFO research here.