Today’s businesses have been dealt a devastating blow, but those companies still carrying the burden of yesterday’s economy face an extra threat – one likely to remain long after the initial shock of the outbreak of coronavirus abates. The sponsors of defined benefit pension schemes have watched in mounting horror as the crisis has laid waste to the value of almost all investments.
“Pension schemes have had a triple whammy,” says Darren Redmayne, chief executive of Lincoln Pensions, which advises companies and trustees.
“The assets that they are invested in have been hit, the liabilities that they have to cover have been enhanced by cuts in interest rates and quantitative easing, and companies are going to be putting less money in.”
Defined benefit pensions, which give retirees a guaranteed income irrespective of the pension fund’s performance, are a distant memory for most British private sector workers.
Defined benefit pensions surplus/deficit since the 2008 financial crisis
The cost of funding them means companies now favour schemes where it is the employee who bears the investment risk. But there are still 5,422 defined benefit schemes in the UK, many of which are no longer open to new members. Funding them has become a pressing problem for companies low on cash. By the end of February, before European economies entered lockdown, their total liabilities to pensioners were already £124.6bn greater than their assets. That deficit is likely to be much wider now.
The first driver of growing deficits is sinking asset prices. Stock markets have been thrashed this year, falling by between a quarter and a third, and fears of company defaults have driven down corporate bond values.
At the same time that assets have been sinking, liabilities have surged. Funds calculate their liabilities based on government bond yields, which means the amount needed to meet future payouts is a moving target from month to month.
Slumping yields have resulted in pensions liabilities increasing 6pc to 8pc so far this year, says Kerrin Rosenberg, chief executive of Cardano, a risk management adviser.
Calls for clemency
For most pension funds the combination of falling assets and rising liabilities means they are 10pc to 15pc further from being fully funded than at the turn of the year, sources say. “We’ve seen a few times where the deficit has barely budged, despite the fact that we’re going through a one-in-200-plus year type of event,” says Adam Poulson, a pensions consultant at Barnett Waddingham.
Because many pension payouts will not be due for years to come, companies still have time to plug gaps in the funding of their schemes. Facing a cash crunch, company boards are clamouring for leeway to reduce or suspend contributions, advisers say.
Most companies are asking to defer payments to repair their pension deficits by six to nine months, says Poulson. Several advisers say they are aware of a small number of delays and reductions that have been granted already, but expect more to follow as fund trustees realise the extent of the problems faced by the businesses to which they are tethered.
The Pensions Regulator has faced pressure to give leeway to employers facing a liquidity crisis but is adamant other creditors, including lenders and shareholders, should share the pain with pension funds, says Bina Mistry, a consultant at Willis Towers Watson.
On Friday, the watchdog said trustees can grant contribution holidays for up to three months while companies seek longer-term solutions and promised further updates to help companies battling to stay afloat.
The regulator is also facing calls from the industry to delay introducing a new code for the funding of deficits.
The new code could add £5bn a year in company contributions to pensions, according to analysis by LCP, a consultancy. “It simply wouldn’t be practical in the current climate to expect employers to be making those sorts of additional contributions,” says Bob Scott, a partner at LCP.
Another potential side-effect is a pause on the £41bn-a-year pensions risk transfer market where firms pay insurers a premium to take pensions liabilities off their balance sheets. Deals like Rolls-Royce’s £4.6bn transfer to Legal & General last year are unlikely to be replicated in the current market as firms do not have the cash to pay a dowry to an insurer to take on their pensions liabilities.
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“We’re seeing cases where discussions were getting pretty close [to completing] and companies are saying ‘hang on, this is a discretionary spend at the minute and we need to pause on this’,” says Poulson.
For schemes that are in deficit, the current crisis means it will take longer to become fully funded – where their assets match liabilities – than they had hoped a year ago, says Redmayne. “But we’ve been here before in 2009 and people worked their way back and no doubt will do so again.”