75% of pension schemes struggling to meet their liabilities, says Regulator

According to its report (20-page / 721KB PDF), around half of all pension schemes could remain on track to meet their long-term liabilities by taking advantage of extensions to their previously agreed recovery plans and increasing contributions. However, a further 25% of schemes will need to make "maximum use" of the flexibilities available in the funding framework due to "affordability challenges" for their sponsoring employers.

The regulator said that it would "work proactively" with the sponsors of struggling schemes to help them meet their liabilities.

"Most schemes will be able to continue with previously agreed plans, or will need to make only slight adjustments," Stephen Soper, executive director of DB regulation. "We believe that the right balance is being struck, in our approach to the DB funding regime, between protecting retirement savers, protecting the [Pension Protection Fund] and maintaining employer viability. But we want that judgement to be understood, which is why we have today published our analysis."

The Pensions Regulator published new guidance (7-page / 85KB PDF) on funding DB schemes in the current economic climate in April. It said that the regulator expected most employers to carry on funding schemes in accordance with plans already in place. Only if there had been a change in an employer's ability to pay should changes be made, it said.

DB pension schemes are schemes that promise a set level of pension once an employee reaches retirement age no matter what happens to the stock market or the value of the underlying investment. The Pensions Regulator regulates UK work-based pension schemes, and has the power to apply to the courts to issue an order to recover unpaid contributions where necessary.

According to the new analysis, the existing funding framework is flexible enough to take into account the different circumstances of individual schemes and employers. It points out that pension scheme recovery plans have increased by a further three years since the schemes were last valued three years ago, amounting to a combined increase of 7.7 years since 2009. Schemes are increasingly using guarantees, security and contingent assets instead of cash contributions, with a sevenfold increase since 2006/07.

The DB schemes analysed by the regulator varied significantly, both in terms of the amount of contributions paid by employers as a percentage of their schemes' liabilities and the discount rates used by trustees to calculate future liabilities.

In its April statement on scheme funding, the Pensions Regulator said that it had considered how best to achieve the "right balance" on ensuring schemes were funded appropriately in a way that remained affordable for employers. It began with the assumption that sponsoring employers "would wish to maintain that level of contributions already committed to" in their recovery plans where possible, it said.

Based on this analysis, 25% of schemes would be able to continue without amending their recovery plans, it said. Around 30% of schemes "would remain on track" to meet their long-term liabilities with a three-year extension to their existing recovery plan and 10% increase in contributions, while a further 20% of schemes "could" remain on track if they also made use of "further flexibilities" in the funding regime, such as allowing for greater investment outperformance as part of their recovery plans.

Industry body the Confederation of British Industry (CBI) said that the regulator was "right to acknowledge" the pressure firms were under to fill scheme deficits. However its Director for Employment and Skills, Neil Carberry, said that "simply offering firms more time to pay" ignored the fact that deficit figures were being "distorted" by the impact of the financial crisis on gilt yields. The yield, or return, on government securities, known as gilts, has been driven down as a result of the Bank of England's quantitative easing policy. DB schemes tend to invest heavily in gilts.

"The current approach to scheme funding forces schemes to estimate liabilities based on gilt prices on a single day," Carberry said. "This is pro-cyclical - many businesses are being forced to pump yet more cash into their schemes, which does nothing for their key goal of delivering growth in the business. Companies need the Government to allow schemes to take a longer-term view of liabilities by smoothing the discount rate used in liability calculations. This is one of the few steps the Government can take to boost growth without spending a penny."

The discount rate is a formula used by a pension scheme's actuary to calculate the cost of providing all benefits currently promised during the scheme's regular valuations. Lower gilt yields and long-term interest rates have an effect this formula.