Hundreds of firms that sponsor DB schemes could face a large increase in pension contributions in the next round of valuations.
Modelling by consultants LCP — based on figures from The Pensions Regulator — suggests that around 300 firms will have to increase their contributions by at least 25 per cent, and this extra bill could run into millions of pounds.
LCP says this increase was largely due to poor investment returns over the past three years. It says companies had poured billions into these pensions in recent years, many schemes are essentially ‘running to stand still’.
DB schemes have to undertake a full valuation every three years, with roughly one third of schemes coming up for a new valuation each year. TPR publishes its own estimates on how the funding position for DB schemes has changed over this period.
The latest ‘tranche’ of schemes is those whose valuation is due between September 2020 and 2021.
TPR research shows that for schemes with a valuation date at December 2020, the average deficit will have worsened (perhaps by around 50 per cent), whilst for those with a valuation date at March 2021, the average deficit will have gone down (perhaps reducing by 50 per cent).
However LCP says there is a big variation around these averages. For example, for schemes with a valuation date at March 2021, TPR estimates that just over half (52 per cent) were in deficit at the last valuation and will still be in deficit at this valuation.
Schemes in deficit are expected to have a ‘recovery plan’ to tackle these shortfalls, and have to make payments known as ‘deficit repair contributions’ (DRCs). For schemes in deficit at the last valuation and expected to be in deficit this time round, TPR estimates that two thirds (66 per cent ) would need to increase their DRCs if they were to stay on track to clear their deficit on the previously agreed schedule.
Nearly half of these schemes would have to increase DRCs by at least 25 per cent, with a small number of schemes (around 1 in 25), needing to treble their DRCs.
LCP estimate that amongst the ‘tranche’ of schemes covered by TPR’s research, several hundred could face an uplift in their DRCs of more than 25 per cent, with the additional bill running into hundreds of millions of pounds a year.
Companies could seek to reduce the impact of these changes by seeking to push back the end date of their recovery plan. However, TPR is currently consulting on a tougher new ‘funding code’ for future valuations which could see further pressure on employers to close deficits more rapidly. This means that the pressure on firms to clear pension deficits is unlikely to ease.
Another alternative for firms is to explore using ‘contingent funding’ for the pension scheme, for example by offering company assets as security in the event that the scheme is unable to meet its pension promises.
LCP parter Jon Forsyth, partner at LCP says: “Although some pension schemes have made progress on the funding of their scheme, there are still many that are no nearer to clearing their deficits than they were three years ago.
“Despite billions of pounds worth of employer contributions going into the schemes, adverse market movements mean that they have been running to stand still. To keep to their original timetable for clearing deficits, the Regulator’s analysis shows that hundreds of employers may have to hike their contributions, in many cases by more than 25 per cent. As a result, we expect the employers sponsoring such schemes will be looking to explore other options including providing other forms of security to the pension scheme or extending the deadline to clear the shortfall.”
