Short-term relief for pension pressures

Despite having made significant contributions to their defined benefit (DB) schemes in recent years, rises in liabilities combined with poor stock market performance means that many companies are likely to face higher reported deficits and contribution demands from their scheme trustees at the next valuation round. A key factor driving up liabilities is recent falls in gilt yields, which are used as a basis for discounting benefits. This reflects the Bank of England's quantitative easing programme as well as an increase in demand for UK debt due to concerns in the eurozone. By way of illustration, yields on long dated gilts fell by about 1.5% since the start of 2011, which will typically increase schemes' liabilities by about 30%-40%. What can be done? The Pensions Regulator has expressed its willingness to allow more flexibility in the period over which deficits are funded at the current time. Beyond that, many companies are looking at innovative asset-backed strategies that use group assets (for example, property, stock or IP) to provide immediate funding to their schemes while substantially reducing cash outflows under a normal schedule of contributions. To control costs, there has been a surge in the number of companies closing their DB schemes for existing members. Clearly such a move is fraught with employee relation issues, evidenced by some recent high profile industrial actions. However, our experience is that a successful outcome can be achieved by articulating the case for change and ensuring employees have a real say in a replacement solution. Critically, we have seen that unions are more accepting of pension changes where a transparent and collaborative process is followed. To deal with legacy scheme liabilities, there are a range of options from a review of the assumptions to liability management ideas. One emerging solution is a pension increase exchange exercise, whereby pensioners are offered a higher level of pension in return for giving up their future non-statutory pension increases. Strict rules exist, but if managed correctly, this can significantly reduce deficits while offering an appreciated option to members. The above options can provide short-term relief, but they should be considered as part of a long-term de-risking strategy to crystallise savings and ensure that the seemingly never-ending DB headache is addressed once and for all.