Is your Final Salary safe in UK post Brexit?

The news broke that UK's 100 largest listed companies face seeing their defined benefit pension costs double over the next three years unless "drastic action" is taken, according to JLT Employee Benefits.

What is Defined Benefit Scheme?

Defined Benefit (Final Salary) pays an annual income in retirement based on employee salary in the final year of employment and length of service. It is usually paid at the rate of one-sixtieth of final salary multiplied by the number of years of scheme membership. So someone who is a scheme member for 40 years would retire on two-thirds of final salary.

When you contribute to a final salary scheme, your money goes into a pot with that of other members. You have no control over your funds or where they are invested. But, if disaster strikes the stock markets just as you retire you will be protected because money purchase your company must compensate any shortfall.

If you wonder if your benefits are secure the answer is yes, ALL pension benefits you have accrued to date in a final salary scheme are safe - as long as the company is liquid. In most cases, companies are closing final salary schemes to new members, but existing members will continue to receive the same final salary benefits while they work at the company.

The only danger is that the company might become illiquid

Defined benefit schemes are protected by the Pension Protection Fund. This pays some compensation to scheme members if employers become insolvent and the scheme doesn’t have enough funds to pay their benefits.

The compensation may not be the full amount, and the level of protection depends on whether you’re:

                       Already drawing benefits

                       Still contributing to the scheme

                       A deferred member who has left the scheme but has built up an    entitlement

JLT made the prediction after it found that 52 per cent of the total amount businesses were spending on their employees was going towards DB pension schemes.

Three years ago, the percentage of employee expenses going into DB schemes was just 26 per cent.

From this, JLT estimated that ongoing DB pensions scheme costs of FTSE 100 companies, which now stand at approximately ￡7bn per annum, could double to ￡14bn over the next three years.

The firm pointed out that a number of FTSE 100 companies had closed their DB schemes this year - including HSBC, Marks & Spencer, Royal Mail Group, Standard Life, and Tesco - and predicted that more would follow.

JLT Employee Benefits director Charles Cowling said the "huge increase in DB pension costs" expected over the next year would force them to take "drastic" action.

"It is difficult to conceive that such a prospect wouldn’t lead the schemes’ sponsors to take some kind of drastic action to mitigate those expenses, particularly as large pension deficits can have a damaging effect on the company’s financial health and, therefore, its share price and dividend payments," he said. 

"As has been seen recently, if a company is in a really bad shape, a large pension deficit could tip it into insolvency. We therefore expect employers to be reviewing any remaining ongoing DB pension provision and monitoring their DB pension deficits very closely.”

In March this year, JLT put the combined FTSE 100 deficit at ￡87bn. It said only 29 companies disclosed a pension surplus in their most recent annual reports, while 59 companies disclosed pension deficits.

Royal Dutch Shell had the biggest pension liability, at ￡57bn, while 15 other companies had liabilities of more than ￡10bn.

So is your Defined Benefit Pension Safe?

This anxiety isn’t helped by the fact there are 4,995 schemes in deficit, representing 84% of the total 5,945 defined benefit schemes, according to the Pension Protection Fund, which pays compensation to members in failing schemes.

This is an increase of 131 over the 4,864 deficit at the end of May 2016 and 361 more than the 4,634 at the end of June 2015. Meanwhile, the number of schemes in surplus is currently 950 – down from 1,081 at the end of May.

Dig further into the data and you find that UK final salary pension schemes had an eye-wateringly high combined deficit of ￡383.6 billion at the end of June 2016 – up ￡89 billion from the ￡294.6 billion level the previous month.

Tom McPhail, head of pensions research at investment company Hargreaves Lansdown, is concerned. He fears the pensions funding gap has now become so large that compromises need to be hammered out between the interested parties.

“I don’t see how employers and British industry will ever generate sufficient income and profits to make good on all the promises made to final salary scheme members,” he says. “It looks like that gap is unbridgeable.”

The ways in which the situation is being managed, he suggests, is flawed.

“You get the assumption of 100% security which is occasionally interrupted by a crisis situation like BHS or Tata Steel where you suddenly have to renegotiate what’s available to the members – and that’s not a satisfactory way of going about things,” he adds.

Final salary schemes, many of which have been closed to new members, provide benefits at retirement that are based on a combination of earnings and length of membership in the scheme.

However, defined benefit schemes being in deficit doesn’t automatically mean they are in danger and members won’t receive their money, points out Patrick Connolly, a certified financial planner with financial advisers Chase de Vere.

“We believe the overwhelming majority of defined benefit pension schemes will be able to pay benefits in full – and even where they can’t there is a strong level of protection through the Pension Protection Fund,” he says.

Pension deficits can act as a drain on companies because it can adversely affect their ability to both invest and borrow money. As a result it can be particularly difficult for them to consider potentially valuable mergers and acquisitions.

It certainly means important decisions have to be taken.

Frank Field, chair of the Work and Pensions Committee, has warned that the problems being encountered by Tata Steel and BHS are not special cases. In fact, he argues such schemes are creaking from rising life expectancy and record low returns on capital.

“Pension law and regulation must urgently adapt to the issues of the future, rather than the problems of the past,” he says. “The whole savings edifice is in danger.”

He has also pledged the Committee will consider defined benefit pension schemes in their entirety, pointing out that the impact on people’s living standards from intergenerational trade-offs of income and wealth were brutal.

“It’s not now simply that children in today’s nurseries will be paying for our pensions and healthcare – it may be that – but the pension promises for today’s pensioners are being stacked up against the jobs of those people who followed them into the firm,” he says.

As an expatriate you might be able to transfer your Defined Benefit Pension and gain several benefits and security not available if you chose to remain in the current scheme.

To find out more about your options and benefits you might get for transferring your pension, feel free to contact me and to appointment for a consultation.