Pensioners in final salary schemes squeezed out of £18bn


Hundreds of thousands of retirees with final salary pensions may be losing out on boosts to their monthly payments to help with the rising cost of living, experts are warning. 

Payments worth around £18billion are being denied to these pensioners, according to Aon, a firm of actuaries. 

Around ten million people in the UK are members of final salary – also known as defined benefit – schemes. These are the most generous type as they pay out a guaranteed income for life based on your earnings. 

Squeezed out: Hundreds of thousands of retirees with final salary pensions may be losing out on boosts to their monthly payments

However, the amount of protection they offer against inflation varies wildly. Most rise with inflation every year, but only up to a cap. Some schemes also offer discretionary cost-of-living top-ups when inflation exceeds the cap. 

Pension scheme trustees can choose to offer these top-ups where they feel it is in the interests of scheme members and the finances of the scheme are in good enough health that they can afford to make an extra payout. 

However, the problem arises when UK companies have offloaded their pension schemes to giant insurance companies in so-called buyout deals. During these deals, behind closed doors, pensioners’ discretionary rights are often signed away. 

Once a pension scheme is in the hands of an insurer, it is no longer looked after by a group of pension trustees with a legal responsibility to act in the interest of its members. 

Instead, the insurance company is simply responsible for maintaining the monthly pension income payments and has no obligation to provide extra help to members in tough financial times. 

Richard Williams is director of strategy and communications at Clara, a start-up pension fund consolidator where discretionary payments are still possible. He says of buyouts: ‘Broadly, insurers have to codify all discretions when they take on a scheme and they’ll usually disappear.’ 

Henry Tapper, chair of AgeWage and a pensions expert, adds: ‘Once insurers have taken on a pension scheme’s liabilities via a buyout, they are under no obligation to pay a penny of any excess profit generated by the scheme’s assets to members.’ Rising numbers of companies are offloading their pension schemes to insurers through buyouts. The deals are huge business for insurance giants such as Legal & General, Rothesay Life, PIC, Aviva and Scottish Widows. 

Actuaries Hymans Robertson estimates that the value of these buyouts could reach a staggering trillion pounds by 2031.

Which pension members will get a pay rise? 

Most private sector defined benefit schemes link their annual pension increases to the Retail Prices Index of inflation, but capped at five per cent or just 2.5 per cent. 

Schemes that have not been subject to a buyout can then top it up. For example, members of one of British Airways’ schemes, the APS, have recently enjoyed a discretionary payment of 1.8 per cent, which brought their total pension increase this year to 4.9 per cent. 

Some of the stingiest schemes do not offer any inflation protection at all, and rely solely on discretionary top-ups. Many trustee boards consider discretionary increases each year as part of their governance process. This year, around six in ten boards have actively considered them, but only a minority have awarded them. 

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Bina Mistry, head of UK Corporate Pensions Consulting at Willis Towers Watson, says: ‘Of 139 defined benefit schemes, 89 scheme trustees have actively considered discretionary increases in 2022 with just 15 granting an increase.’ 

The value of discretionary top-ups has not been seen for nearly 30 years as inflation has remained subdued. But as RPI inflation hit 12.3 per cent in August, pensioners unable to enjoy top-ups will quickly see the value of their incomes eroded. Tom Selby, head of retirement policy at investment platform AJ Bell, says: ‘If we had five per cent inflation for five years, a £10,000 pension income without inflation protection would be worth £7,738. If we had five per cent inflation for ten years, it would be worth just £5,987.’ 

Among those denied top-ups are the 277,000 pensioners whose retirement fund has been taken over by the Pension Protection Fund. This organisation acts as a lifeboat and takes over pension schemes of companies that go bust and cannot meet their pension liabilities. 

It has no power to award discretionary top-ups, which means that retirees in the schemes that it controls receive a maximum increase of 2.5 per cent every year – even if inflation far exceeds that level. 

The PPF says: ‘We were set up by government to pay members of eligible defined benefit pension schemes compensation for their lost pensions if their employer failed. Our compensation levels – including levels of indexation – are set out in legislation.’

How do I get a top-up for my pension? 

It is often up to scheme members and unions to press the case for discretionary pension increases. William McGrath, chief executive of C-Suite Pension Strategies, encourages them to ‘be more active in raising questions about what is in their best interests’. 

He adds: ‘Where a pension scheme is well funded, they can ask trustees for more.’ 

Hilary Salt, a partner at First Actuarial LLP, advises that members can look at whether their pension scheme has offered significant increases in the past – and then use this as a bargaining tool. 

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