Covid Carnage Part 2: what's the outlook for my Company pension?

This is the second part of my pensions article, written in response to a number of PM’s recently received from former colleagues, friends and associates asking similar questions about their respective pensions following the dramatic Covid led sell off of worldwide stock markets.

This article is only about defined benefit (DB) pensions arranged by employers.

Click here for the article on defined contribution (DC) pensions such as SIPP’s.

The following is not investment advice, and should not be taken as such. It is my personal opinion based on over 30 years of investing in the stock markets, and of my experience as a former pension scheme trustee and chairman.     

Defined Benefit Schemes

The general gist of the questions I have received in respect of DB schemes are along the lines of:

1.      Is my accrued pension safe following the recent market sell off?2.      Is my pension safe if my employer fails in the wake of the pandemic?3.      Can my employer change the pension scheme rules if it wants to, to the detriment of future pensioners?     

Is my accrued pension safe following the market sell off?

Yes and no. Firstly, if you have a strong employer with a strong covenant for paying current and future pension contributions, plus any additional contributions it is required to pay as part of its deficit recovery plan, then so long as the sponsoring employer remains in business post pandemic, your accrued pension should be safe.

Your accrued pension entitlement will be a promise to pay a certain sum, based on some scheme specific factors that are not directly influenced by a stock market crash. If your pension promise is to receive 40/60ths of your final salary, then that promise remains intact even if the stock market plunges 50% or more. The fact your sponsoring employers pension funds have halved from say ￡100m to ￡50m doesn’t make any difference at all to your eventual entitlement.

That’s all well and good for those with strong employers who can survive the pandemic and imminent recession, but for those with weaker employers, the 2nd question below may be applicable.

Is my pension safe if my employer fails in the wake of the pandemic?

Again, the answer here is both yes and no. Thanks to the PPF (Pension Protection Fund) or pension’s lifeboat as it is sometimes known, there is protection of your accrued pension rights, but in many circumstances it is not full protection.

If a pension scheme is eligible for PPF entry, the level of benefit payable depends on the pension scheme member’s circumstances immediately before the assessment date and the pension scheme rules.

Members who are entitled to 100% compensation include pension scheme members over the pension scheme’s normal pension age.

In broad terms and in normal circumstances, this means a starting level of compensation that equates to 100% of the pension in payment immediately before the assessment date.

However, no pension increases are provided in respect of pensionable service prior to 6 April 1997 and compensation that is derived from pensionable service on or after that date is only increased each year in line with CPI capped at 2.5%. This could potentially result in a lower rate of increase than the scheme would have provided, especially if your schemes annual increases were pegged to the higher RPI index.

Members who are entitled to 90% of the “compensation cap” include:

Pension scheme members below the pension scheme’s normal pension age (including early retirement pensioners); and deferred pension scheme members.

Active and deferred members will only receive their pension on reaching the pension scheme’s normal pension age.

Again in broad terms, and in normal circumstances, this means 90% of the pension an individual had accrued (including revaluation) immediately before the assessment date (subject to a review of the scheme rules by the PPF) plus revaluation, currently in line with the increase in CPI between the assessment date and the commencement of compensation payments. Revaluation is subject to a cap of 5% in respect of service from April 1997 to April 2009, and 2.5% in respect of service thereafter. These caps apply in deferment.

Once compensation is in payment, pension increases are applied in the same way as outlined under “100% compensation level” above. Again, this could result in a lower rate of increase than the scheme would have provided.

Note that the compensation is also subject to an overall cap, which, as at April 2020, equates to circa ￡41,000 at age 65 before the 90% has been applied (the cap will be adjusted according to the age at which compensation comes into payment). Therefore, if you are a high earner, and have built up a significant deferred pension promise, then you could significantly lose out if your pension ends up with the PPF.

Can my employer change the pension scheme rules if it wants to, to the detriment of future pensioners? 

In short yes. In most trust deeds and rules there will be an option for the sponsor to change the rules of the scheme following consultation with the scheme trustees and ultimately scheme members, (and with the Court in some instances). It isn’t an easy or quick process, and certainly isn’t popular with scheme members, but rules can be changed in about 6-12 months if the Courts are not involved, or longer if they are.

Post pandemic, when surviving employers are looking for ways to reduce costs, it wouldn’t be unusual for DB pensions to be in the firing line once again.

Employers who still operate open DB schemes may look to reduce the benefits available, such as reducing from a final salary to a career average salary scheme, or closing it completely. Those who have already closed their schemes may seek to amend the rules, such as amending the RPI indexation to the lower CPI level, or reducing the formulas used to calculate tax free lump sum payments, both of which will cost future pensioners a small fortune.  

Phil Bellamy FCII, Managing Director of Tibbington Consulting Ltd

Phil has been underwriting ATE and BTE legal expenses insurance for more than 30 years, and now provides help and assistance to senior figures in the insurance, legal and litigation funding industry. Click here to view Phil’s credentials document.