Providing pensions in the current environment: what can employers do to manage cost?

Impact of the volatile market on pensions

2008 proved to be an extremely challenging year for UK pensions, for the companies who fund them and for the individuals expecting to draw an income from them.

For companies with defined contribution schemes (DC), employees may need to defer retirement in order to increase pension income. This can lead to difficulties in workforce management and morale. The question is whether employees really value the pension provided by employers.

For companies with defined benefit (DB) schemes, the financial picture is harder. In 2008, the Pension Protection Fund estimated that the aggregate private sector deficit grew to almost £195bn, up from £20bn a year before (an increase of almost 1,000%).

Managing DB pension costs – future accrual

In light of the downturn, companies are faced with the dilemma of managing costs whilst at the same time funding higher deficits.

In many cases, DB pension provision has simply become uncompetitive. A recent PwC survey showed that 16% of DB schemes no longer provide any further accrual, and this figure is anticipated to increase to 30% in the next five years.

We therefore expect pension scheme redesign to feature highly on board room agendas in 2009, with companies either reducing the cost of their DB schemes or moving entirely to DC.

Managing DB pension costs – historical accrual

For many companies, the largest cost (and risk) is often associated with former employees’ pensions. In the past, these benefits have been considered sacrosanct; but companies are now using innovative strategies to reduce these liabilities, such as:
1) Offering benefit options better designed to suit member needs, but at a lower cost; and
2) Offering incentives to transfer out their benefits.

In one recent example, a company removed 15% of the pension liabilities from its balance sheet.

Managing cash negotiations with trustees

Whichever strategies are considered for managing pension costs, the cashflow impact must be carefully managed.

Contributions required to fund a deficit are usually set following an actuarial valuation. The scheme’s trustees will look to determine:
1) what the deficit is, and
2) an appropriate repayment period.

There is considerable scope for negotiation.

Implementing the options highlighted above may give the company a higher return on investment than simply making contributions to the scheme. We are seeing an increasing incidence of cash alternatives – e.g. guarantees, charges over assets. And of course there are the usual negotiations about appropriate assumptions for future investment return and longevity amongst others.

The Pensions Regulator has said that it expects to see longer recovery plans adopted over the next year. Employers may have an opportunity to renegotiate where appropriate.

To conclude, 2009 will be challenging for businesses on a number of fronts, as acknowledged by the Pensions Regulator. There are opportunities to reduce pension costs, which could also bring a significant longer term advantage.

Contact details
Email: Peter Woods
Tel: +44 (0)113 289 4093