Money in the bank: Final salary schemes have given workers a decent retirement
The last of the country’s deluxe defined benefit company pension schemes are likely to be swallowed up by a small clutch of insurers within the next decade. But experts believe that those with benefits tied up in these schemes should not panic.
A remarkable 20th Century innovation, these company pension schemes have given millions of workers a decent pension on retirement.
Promising a pension based on a worker’s salary and their length of service, they have been described by Sir Stephen Timms, Labour MP and chair of the Work and Pensions Select Committee, as ‘one of the best things our country ever did’.
But as a result of mounting costs (to employers that provide them) and tougher regulations, four million people in the UK’s 5,000 remaining schemes could find their employer will no longer pay their pension.
Instead, an insurance company will take over – household names such as Aviva, Canada Life, Legal & General and Scottish Widows. According to pensions consultant Hymans Robertson, around 1.4 million individual pensions have already been taken on by insurance companies.
Verity Hastie, a risk transfer specialist at Hymans, says: ‘From the moment that an insurer takes on the obligation to pay a scheme’s benefits, they are required to have sufficient capital tucked away to ensure they can pay out all the pensions promised, even under stressed circumstances.’
She adds: ‘Insurers are capitalised, at a minimum, to withstand a one-in-200-year catastrophic event – for example, a stock market meltdown. Most hold reserves significantly in excess of this requirement.’
CHRISTOPHER Stiles, of law firm Gowling WLG, says: ‘If a pension acquisition by an insurer is done properly, and most are, members’ rights won’t change.
What changes is who is responsible for delivering those rights – an insurer instead of pension fund trustees – what assets are standing behind them, and how it is all regulated.’
Those who are a member of an employer scheme that transfers to an insurer should ensure their contact details are up-to-date.
The insurer will also request evidence, such as marriage certificates, bank statements and evidence of co-habitation before paying a spouse’s or dependant’s pension.
While an insurer will not renege on pensions promised under the old employer-sponsored scheme arrangement, not everything will be the same.
For example, fringe benefits to members – such as pensioner lunches, access to financial education and advice – may be lost. But, more importantly, members will lose any chance of getting better benefits than those promised – for example, through discretionary pension increases.
Research by pension consultant Willis Towers Watson shows that only ten per cent of schemes granted discretionary increases in 2022, but six out of ten trustees considered doing so.
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This has become more of a current issue with inflation in double figures and many pension schemes capping annual increases at a maximum 5 per cent.
In terms of protection, a pension scheme taken over by an insurer provides members with greater assurances. The Financial Services Compensation Scheme provides a lifeboat to policyholders in the event of an insurer failing. This currently covers 100 per cent of pension benefits.
In comparison, the equivalent lifeboat scheme in the defined pensions landscape is the Pension Protection Fund. It typically results in member benefits being compromised.
Insurers take over defined benefit pension schemes to make a profit. The more surplus assets that a scheme has to meet future liabilities from members drawing an income, the more likely it is to be snapped up by an insurer. Henry Tapper, founder of pension firm AgeWage, says: ‘Where an employer’s capacity to meet further cash-calls from pension trustees is compromised, a buy-out by an insurer is likely to be good news.
‘But sadly, weakly sponsored schemes are usually weakly funded and in a buyer’s market, weak schemes are unlikely to get bought out.’
Tapper is also worried about the ‘concentration risk’ caused by such a small pool of insurers prepared to take on the liabilities of pension schemes. He warns: ‘A failure of just one of these insurers could wreak far more damage than Maxwell or Equitable Life ever did.’
Joe Dabrowski, deputy director in charge of policy at the Pensions and Lifetime Savings Association, agrees. He says: ‘There are potentially future systemic concentration risks which the Bank of England and Prudential Regulation Authority (PRA) will need to be alive to.
‘But the current regulatory regime and solvency standards required of insurers are robust, providing pension members with strong levels of protection.’
The PRA is currently undertaking a ‘thematic review’ of insurers involved in the purchase of pension schemes. But systemic failure is remote.
Most people may find that their pension prospects improve on moving to an insurer.
Chris Rice of consultancy Broadstone says: ‘The member will no longer need to worry about the sponsoring employer’s financial health.’
Rate rises wreck 15 years of gains
All the investment gains made by private company defined benefit pension schemes since the 2008 financial crisis were wiped out in just nine months of rising interest rates, new analysis shows.
The market value of these funds plunged by £545 billion, or 30 per cent, between December 2021 and the end of September 2022, latest figures from the Office for National Statistics show.
This huge destruction in asset value was made worse by the fall-out from former Chancellor Kwasi Kwarteng’s mini-Budget of unfunded tax cuts last year.
It spooked markets and sent the price of government bonds plummeting.
The rout revealed previously hidden leverage – or borrowing – lurking in defined benefit schemes that used so-called liability driven investment (LDI) strategies that were meant to reduce risk.
Instead, funds were forced into a fire-sale of assets as they scrambled to cover losses.
Only a £19 billion bail-out from the Bank of England prevented a collapse of the pensions system.
Now experts have calculated that the scale of those losses more than offset the gains made since LDIs were first adopted 15 years ago in a bid to match scheme liabilities – the promise to pay future pensions – with funds’ assets.
‘It is evident that in earlier periods these LDI strategies had produced substantial returns, but these gains have now almost all been given back,’ says Iain Clacher, pensions professor at Leeds Business University who crunched the numbers. He adds: ‘After costs and expenses, these strategies showed negative returns.’
Clacher, who recently gave evidence to lawmakers investigating the LDI scandal, first sounded the alarm on the likely scale of pension fund losses in The Mail on Sunday, but even his estimates have proved conservative.
Nearly all of the 5,000 workplace defined benefit pension schemes are now closed because employers across many sectors have found them too expensive to run.
Experts say scheme funding levels have improved because the present value of liabilities, linked to bond prices, fell faster than assets. But Clacher says some of the improvement came from increased employer contributions.