The £1 trillion pensions black hole

Guest blog from Malcolm Small, Executive Chairman, Retirement Income Alliance, 16th June 2016

With the departure of Ros Altmann from government as Pensions Minister, she is now free to commentate and campaign, this time from the exalted platform of the Upper House, at the House of Lords. She has already made a number of interventions likely to irritate the government, revealing unpleasant truths that many vested interests would wish to keep away from the light of day.

Her most recent commentary was around the effect of the Bank of England's interest rate cut from 0.5% to 0.25%. Quite apart from representing a 50% 'haircut' in income for anyone attempting to live off the interest from money in the bank, this move could have serious implications for employers trying to manage Defined Benefit (DB) pension schemes.

These schemes promise to pay a certain percentage of salary as a pension in retirement. This 'guarantee' needs to be funded by the employer, and with people living longer, most schemes are running a 'deficit' - the difference between the cost of future pension payments and the assets held by the scheme.

Where the deficit is large, the Pensions Regulator may require the employer to put more assets into the scheme, reducing profits and, potentially, the share value of the employer. This is serious stuff, and large pension deficits have caused normal corporate activity, such as takeovers, to come to a grinding halt, with Tata Steel being a recent case in point. Hymans Robertson, the pension consultancy, recently estimated the aggregated deficit on UK DB schemes to be close to £1 trillion!* This is a gigantic financial hole to be filled by UK employers.

It's getting worse, not better

Ros’s point is that lower interest rates lead to lower yields on government bonds, which DB schemes commonly buy to 'match' their known forward liabilities for pension payments. As the bond yields fall, they have the effect of increasing deficits while at the same time making it harder for schemes to keep up financially.

All this means that employers have to put aside yet more money; money that in some cases they simply don’t have. This, in turn, leaves the only option being a breach of the 'promise' and a reduction in benefit levels (which the law prevents scheme trustees from doing right now), or corporate insolvency and resolution of the scheme in the Pension Protection Fund, frequently resulting in benefit reduction in any case.


The government has said that it is prepared to legislate to enable benefit reductions in the legacy British Steel pension fund. This would allow the huge deficit in that scheme to be reduced, or closed altogether, as part of a package to help Tata to 'hold on' in the UK. It has been said that such legislation would be case-specific.


But DB scheme deficits across the country are massive, getting rapidly worse and, in many cases, arguably beyond redemption. It seems to me that the days of DB 'promises' on pensions being sacrosanct must surely soon be over.


Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Malcolm's views are his own and do not constitute financial advice.


*https://www.hymans.co.uk/news-and-insights/news-and-blogs/news/uk-defined-benefit-deficits-hit-1-trillion/

Published on 02/09/2016