Analysis published by the Pensions Regulator today confirms that defined benefit pension schemes with actuarial valuations this year are behind schedule when it comes to eliminating their deficits.  Many will have bigger deficits than they did three years ago despite the billions of pounds that employers have paid in.

The Regulator estimates that, for the median scheme, deficit contributions would need to rise by 66% if the timetable for eliminating the shortfall were not pushed back.  For most schemes, the deficit recovery period would need to be extended by more than three years if contributions stayed the same.

Commenting on the Regulator's Annual Funding Statement, aimed at the trustees and employers who must agree new funding plans against this difficult backdrop, Adam Boyes, a senior consultant at Towers Watson, said:

Longer recovery periods vs higher contributions

Pension Nest Egg"Typically, schemes will now anticipate staying in deficit for longer.  According to the Regulator, 'many' employers 'may' be able to pay higher contributions than they are doing – in almost one third of the cases for which it presents data, deficit contributions would eat up no more than 10% of pre-tax profits even if they were increased to stop recovery plans from lengthening.  But the Regulator no longer says that deficits should be cleared as quickly as employers can reasonably afford; companies who don't want to put their hands in their pockets are very conscious of that.

"Only a subset of schemes – those with limited capacity to take more risk and where the employer can afford to pay more – have been guided to 'seek' to clear their deficits according to the original timetable and at the employer's expense.

"For schemes 'which have previously taken a more prudent approach,' or where the employer covenant has improved, the Regulator gives a green light to using slightly riskier assumptions, which can reduce the impact on contributions or recovery periods."

Reaching agreements without knowing if higher interest rates will ride to the rescue

"Employers of schemes that have not previously hedged their exposure to interest rate and inflation risks will be reluctant to pay to fix a problem that might anyway disappear if bond yields rise; trustees won't want to rely on yields rebounding with no Plan B.  Escrow accounts could well become more common – here, employers must put money aside now but can get it back if markets do the heavy lifting for them.  The Regulator is not trying to block schemes from assuming that yields will rise by more than the market currently implies, but says they should at least do some contingency planning around this."

How will funding agreements be policed by the Regulator?

"Today's statement is not an instruction manual.  That's good, but trustees and employers may have welcomed more clarity about what would cause tPR to reject their agreements and impose different ones – something it has yet to do as it begins policing its 10th round of valuations."

Taking account of 'pension freedom'

"The Regulator has told trustees to seek advice on how their funding plans would be affected if more members transferred out of the scheme to access their pension wealth flexibly. The world has changed and funding assumptions will eventually have to change with it. Some schemes will not want to incorporate this into their central view without evidence of how many members are actually cashing out their pensions, but they can still think through different scenarios. Transfers will sometimes take liabilities off the scheme's hands for less than the budgeted cost of paying pensions, but this will not always be the case."

About Towers Watson

Towers Watson (NASDAQ: TW) is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. With 15,000 associates around the world, the company offers consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management. Learn more at towerswatson.com.

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