Even before last Thursday’s interest rate cut, pension deficits were at record levels with the total gap between assets and liabilities for Britain’s companies estimated at a mind-boggling £390bn.
The rate cut exerted further downward pressure on gilt yields - a key determinant in pension liability valuations - meaning that the gap is likely to grow further. Initial estimates put that as another £30bn to £50bn added to liabilities.
Growing deficits heap pressure on pension scheme trustees to request further cash top-ups from sponsoring companies.That creates its own waves. The concern from experts is that if trustees and regulators pressure companies too hard to bridge funding gap it could push them into insolvency.
As Tom McPhail, head of retirement policy at Hargreaves Lansdown says, this means less cash to be invested into industry, to be paid out to shareholders, and to fund employee pay increases. It also means less tax going to the Treasury because the tax deductibility of cash-tops reduces the corporation tax paid by companies to HMRC.
McPhail says that trustees are “duty bound” to make cash requests, though the current level of wriggle-room within this partnership is a matter of debate.
“There is not enough flexibility as to how these [deficits] are managed. There needs to be a mechanism where trustees can send up a distress flare to the Pensions Regulator,” says McPhail.
While pension scheme liabilities do not necessarily form the sole basis of trustee cash top-ups, they tend to guide discussions with the company.
Liability calculations typically are based on a series of assumptions and linked to gilt yields. McPhail believes that this methodology is a contributing factor to putting companies under undue pressure. He believes authorities should help by encouraging schemes to review their valuation methodology.
Pensioners get less?
Arguably a more drastic approach could be to address inflation increases in pay-outs to scheme members.
This is another option McPhail suggests and follows the example set by public sector schemes in 2012 when the measure of inflation was changed from RPI to the lower CPI index. This effectively took a knife to future pay-outs to members.
Whether such a change can be made depends on if the inflation measure is hardwired into scheme particulars. And even if it isn’t, there could be significant pressure against such a change, as was experienced by British Airways in 2011.
Lincoln Pensions managing director Alex Hutton-Mills highlights the importance of looking at schemes on a case by case basis.
He doesn’t think that there should be an enforced change from RPI to CPI. Instead, he suggests putting in place a range of parameters that would indicate when a scheme is unlikely to be able to repay members in full. “Weaker schemes need [to be given] more tools in their toolboxes,” he says.
Former pensions minister Steve Webb, who is now at Royal London, has concerns about forcing all schemes to move to CPI as it could let some pension schemes off the hook unnecessarily.
“Watering scheme pay-outs is a dangerous promise. There are plenty still out there that can still afford to pay off in full,” he says.
Webb also makes a key point on trustees responsibilities. He says that their duty is not necessarily to make requests for cash but to “maximise the chance of pensions being paid in full”.
“I like to see it as a partnership rather than a confrontation. We need to avoid making a knee-jerk reaction. There is more flex in the system that outside observers think,” he says.
One example of such flex, according to Webb, is the way in which schemes can adjust seven year recovery plans agreed between trustees and employers. With a plan in place, if circumstances change materially, recovery plans can be amended and reset.