Old-style pensions are fixed. Now for their poorly funded successors
Commuters at London Bridge
The traditional corporate pension has an outsize influence on British business, even though most have now closed to new members. At last, the focus is shifting. In 2023 — for the first time — old-style defined benefit schemes absorbed less FTSE 350 cash than the defined contribution pots that have increasingly taken their place.
The latter does not offer workers the certainty promised by DB schemes that pay pensions based on salary and length of service. But DC schemes can play a more constructive role in UK growth. Over the past two decades, DB schemes have shifted out of equities and into bonds. That provided the government with low-cost funding, but restricted the capital available for riskier investments.
The cost of meeting DB pension promises soared amid rising longevity and low interest rates after the financial crisis. The resulting deficits forced FTSE 350 companies to pump nearly £90bn of extra contributions into DB schemes over the 12 years to 2023, according to professional services consultancy Barnett Waddingham. In total, they contributed £161bn to DB schemes, 89 per cent more than they contributed to DC schemes.
When long-term bond yields rose, DB scheme assets fell nearly a third to £1.2tn in the five quarters to early 2023, according to the ONS. But their liabilities fell even more. Many schemes locked in the resulting improvements to their funding positions, using matched assets, longevity swaps or insurer buy-ins.
In aggregate, fully funded FTSE 350 companies have an aggregate surplus of £45bn. Allowing easier access to these surpluses would boost UK plc, the Conservatives argued. More relevantly given this week’s election, Labour also wants to boost investment. It has promised a pensions review but details are sparse.
If surpluses are to be distributed, who should benefit: shareholders, pensioners or the existing workforce? Employers who funded extra contributions to repair deficits have an obvious claim on any refunds, although that comes with reputational risk. For 13 of the companies with a surplus, there is enough to fund two years of dividends.
Retirees whose pensions have lost value due to inflation can persuasively argue for an increased payout. But there is also a strong case for improving the pensions of the existing workforce. Almost two-thirds of households saving into a DC pension cannot expect even a moderate standard of living in retirement, according to the Pensions and Lifetime Savings Association.
The pension deficit horror story of recent years underlines the need for caution in distributing surpluses. But the improved health of DB schemes is an opportunity to turn the spotlight on the poorly funded pots that replaced them.