The Pension Protection Fund’s (PPF) 2019 publication regarding the state of the defined benefit (DB) nation springs few surprises.
Funding is improving slightly, membership is going down and the PPF believes it is sufficiently funded to meet its liabilities. Sounds good but are these trends set to continue, and what are the potential disruptors that could impact in the near future?
On average, scheme funding levels have improved to 99.2%, up 3.5% from 2018 and 2.1% from 2006 when the PPF was set up. Welcome news but it makes it easy to overlook the fact that funding levels have fluctuated a fair bit between these 2 points and there are still 200,000 people in small schemes which are less than 75% funded.
In fact, most very small schemes, with less than 100 members, are likely to be fully funded, as are the very large schemes of more than 5,000, suggesting that it is the trustees of medium-sized schemes who are finding it hardest to reduce their deficits. Against this, the very small schemes, although well-funded, are more likely to face insolvency issues with the sponsoring employer.
According to the book, there are 10.1m people who still have DB pensions, of which only 11% are still active. Of the remainder, 42% are pensioners and 47% are deferred members. Benefits for active members still require funding but at least they are still working and providing value to the sponsoring employer, while pensioners have already done so.
It is not surprising that the proportion of pensioners is increasing, but the good news is that the more mature schemes tend to be the best funded, with 87% of schemes that have over 75% of their liabilities relating to retired members being fully funded. On the other hand, only 24% of those where over 75% are yet to retire have fully covered their liabilities.
The Purple Book mentions the Bauer effect , Brexit and the Pensions Regulator’s new funding framework as potential risks to its funding model, alongside the change from RPI to CPI revaluation and the impact of commercial consolidators who could impact on levy receipts.
On top of this there’s the ‘business as usual stuff’ – increasing longevity, continuing low gilt yields and the administrative challenges of GMP reconciliation & equalisation and getting data ready for the pensions dashboards.
All in all, it’s not easy running a DB scheme, and while it might just about be worth it as a highly-prized benefit for current workers, employers may feel less sanguine about those who have already left. It may not actually have been the member’s choice to become a deferred member, as 16% of schemes are closed to future accrual, but there is little doubt that many trustees would not be sorry to see them leave.
There are a number of ways the deferred membership might decrease, each with their advantages and disadvantages:
|1. They could be left alone to reduce naturally as people retire and take their benefits.||Less need for short term capital, funding can be spread over the term to NRA.||Liabilities remain with the scheme and could increase faster than the value of assets.|
|2. Their benefits could be bought out or insured.||Liabilities are transferred entirely away from the scheme.||Potentially huge up-front cost to secure benefits.|
|3. They could transfer out.||Liabilities are transferred away from the scheme on a member by member basis.||Strict rules apply to incentive exercises and where the value of benefits exceeds £30,000 members must take financial advice.|
Option 1 is the scenario that the PPF seem to be working on, leading to the long, slow demise of final salary schemes in favour of defined contribution (DC) in the private sector.
Option 2 is growing in popularity but is still being used by a relatively small number of schemes, and by those that are in any case the most well-funded.
This is one reason why the dwindling supply of financial advice required to facilitate Option 3 is so concerning.
While I don’t dispute the Financial Conduct Authority’s statement that most members are better off remaining in their scheme, action needs to be taken to augment or replace professional indemnity insurance for advisers operating in this field, in order for those members who could benefit from more flexibility in retirement to access it.
Unless something changes both scheme and member seem largely stuck with each other until they are eventually all retired.
Fiona Tait is technical director at Intelligent Pensions