All FTSE350 DB schemes likely to close to future accrual within a decade due to cost pressures
04 Dec 2017 - Estimated reading time: 3 minutes
Over half (55%) of FTSE350 companies have already closed their Defined Benefit (DB) schemes to future accrual and by 2027 accrual is likely to be switched off altogether, as companies take action to reduce the cost of DB pension provision, according to Hymans Robertson’s latest FTSE350 Pensions Analysis.
The costs of DB pensions are set to rise for companies sponsoring them as there will be pressure to increase deficit contributions from the Pensions Regulator (tPR) post the BHS and British Steel cases. This is in the context of future DB pension promises already costing employers 40-50% of pay.
Commenting, Jon Hatchett, Head of Corporate Consulting at Hymans Robertson, said:
“Following the resolution of the BHS and Tata Steel pension cases tPR is now taking a tougher line of DB funding. The upshot is companies will be under greater pressure from trustees, with the backing of the Regulator, to pay more cash towards deficits. We’ve seen a pendulum swing away from the recognition that a strong employer is better able to support its pension scheme, to an expectation of annual deficit contributions increasing when schemes are behind plan.
“The Regulator’s messaging is bang on for situations where affordability is stretched and covenant risk is high. In these circumstances getting the cash in while you can makes sense. But only 5% of schemes are in this position.
“The only companies that will be clear of the requirement for more cash are those that have hedged most of their inflation or yield risk, and that are therefore still on track, or those where affordability is genuinely stretched.
Explaining why this focus on contributing cash could have unintended consequences, he added:
“The focus on deficit contributions is too simplistic. Worse, it creates an incentive to take more investment risk at a time when for many maturing schemes these risks should be dialled down. The prevailing sentiment that ‘longer recovery periods are bad’ should be challenged. A longer recovery period, with a plan that has a greater chance of achieving its targets, can be better for employers and scheme members. We must remember that DB pension promises typically extend for the best part of a century, we don’t need to rush towards the exit and risk tripping over our own shoelaces.”
Underscoring the fact there is too much investment risk in the system, he added:
“While most schemes are affordable to their companies, with 85% of the FTSE350 able to pay off their deficits with 6 months’ earnings, there is too much risk in the system. Many schemes are still investing too much in volatile equity heavy portfolios leaving too much to chance. Equities are at half the level expected back in 2000. The interest rate bets taken by schemes have increased liabilities by well over 50% since then and longevity risk has added another 15%. That’s despite companies committing hundreds of billions of pounds towards pension schemes over the same period. Yet accounting deficits now stand at £115bn for the FTSE 350 at 31 August 2017, and the buyout shortfall for these schemes is around four times larger again. The big bets taken so far this millennium haven’t paid off. And pouring more cash into schemes hasn’t worked. So why do we think it will now?”
Explaining why companies that pay out more in annual dividends than they pay into pension schemes can expect to come under greater scrutiny, he added:
“tPR has noted that dividend payments have increased materially over the past 6 years while deficit contributions have remained stable. We’ve analysed the FTSE350 data and broadly agree with tPR’s findings. However, blanket figures don’t tell the whole story. If schemes are under control and have well managed their risks, company directors should have the freedom to pay as much as they see fit to shareholders.”
Concluding, he explains why we’ll see more scheme closures:
“Our analysis shows that 55% of FTSE350 companies have already closed their DB schemes to future accrual. Falls in yields mean required future service contributions can now be 40-50% of pay. This, coupled with the pressure to increase deficit contributions, will lead to even more companies taking further action to reduce costs and closing to future accrual. If we project the current trend forward, we expect future accrual to be switched off altogether in the FTSE350 by 2027.”