DB costing 50pc of salary – pushing deficit to £1trillion

Trillion The cost of providing a defined benefit pension now equates to 50 per cent of pay, with low gilt yields caused by post-Brexit market uncertainty pushing deficits to a record high of £1 trillion, according to Hymans Robertson.

The consultancy also argues that the negative long-term market projections means the proportion of workers with DC pensions likely to see a retirement shortfall has risen from two thirds to three quarters. Hymans’ analysis of 500,000 DC savers pension plans on its Guided Outcomes platform shows an increase in DC savers being hit because of its view that long-term investment returns will be lower as a result of Brexit.

Hymans predicts that the remaining private sector DB schemes will now close as a result of this soaring cost. It also warns that individuals could lose a significant proportion of their benefits if they fall into the PPF, with those with bigger pensions being hit hardest.

Hymans Robertson head of corporate consulting Jon Hatchett says: “Post Brexit and the Bank of England’s policy response to economic uncertainty caused by the UK’s decision to leave the EU, the cost of providing a DB scheme has risen to 50 per cent of pay. This is clearly unsustainable for the majority of employers. Unsurprisingly we’re likely to see the last remaining open private sector schemes close and a number of high profile employers have indicated in recent weeks this is a path they’ll be forced down.

“Back in March 2015 there were 11m people with a DB scheme, but only 1.75m were still accruing benefits. Since then we’ve seen a large number of closures. When the new flat rate state pension was introduced in April this year, costs increased for many DB schemes due to the end of a ‘contracting out’. This was a catalyst for many to close their scheme. Due to plummeting gilt yields and a less favourable outlook for asset returns, this is only the beginning of the end for open DB schemes.”

“It’s good the Work and Pensions Select Committee is looking at the issue of sustainability of DB, as the figures involved are gargantuan by any measure.  Either companies are going to have to pay more – at the cost of investment, jobs or salaries; or pensioners are going to lose out.  The reality is probably a combination of both.

“Back in December the Pensions Policy Institute estimated that one in six DB schemes wouldn’t make it. Our own research among FDs at the beginning of the year supported this, with one in seven finance directors saying their DB scheme was a major risk to their business.

“Since then, deficits are up by over £250bn or over one third. Brexit has lowered expectations of asset returns, and provided a shock to some sponsor’s business models.  This is only going to increase the rate of scheme failures compared to the PPI study. There will be winners and losers across schemes, both in terms of the impact of Brexit on their business and the impact on scheme funding.  Companies and trustees will need to tackle the challenges, or opportunities, on a case by case basis.  On average though, DB pensioners and the companies that support them are much worse off.

“Expected lower returns from assets due to an uncertain economic outlook don’t just hit those with relatively generous DB schemes. The majority of the working population will be saving into and retiring with DV pension pots. Our analysis shows that post-Brexit, the number of DC savers who will retire on an inadequate income has risen from two thirds to three quarters. Many will be falling back on the state pension, but that will be lower for the majority too.

“We should not be lulled into a false sense of security with auto-enrolment. While it’s been a huge success with low levels of opt-outs, with contributions at 2 per cent of pay it doesn’t even come close to securing a decent retirement income. It now takes 50 per cent of pay to fund a decent DB pension at current retirement ages. You don’t have to be an actuary to see that this is a car crash waiting to happen. The hike up to 8 per cent of contributions in 2017 doesn’t go nearly far enough.”