A government discussion paper on the future of defined benefit (DB) pensions has said that firms struggling financially might be allowed to reduce the benefits promised to members (1).
It is estimated that around eleven million people are members of private defined benefit pensions (2). These schemes are where an employer promises a specified pension payment on retirement, usually calculated by a formula based on the employee’s earnings, length of service and age, rather than on individual investment returns.
The government green paper estimated that around 5% of businesses running private DB schemes are in trouble (2) although for most DB pension schemes remain viable even though most are in deficit. The paper suggested several ways in which they may be able to alter their scheme to alleviate financial stresses.
One method highlighted was to allow companies to change the way pensions are uprated each year to compensate for inflation. Where firms now use the Retail Prices Index (RPI) to uprate they could start using the traditionally lower Consumer Prices Index (CPI) to save themselves some money (1). Most of the UK’s defined benefit schemes have already made this money saving change.
It is estimated that this change could cost the average pensioner up to £20,000 a year (3). Previous pensions minister Steve Webb has reacted quickly to the green paper suggestion and has said allowing the change to CPI would be worrying.
“There is a significant risk that relaxing standards on inflation protection – with the best of intentions for exceptional cases – could be exploited and lead to millions of retired people being at risk of cuts in their real living standards” (3).
In addition to a move towards CPI the government paper also outlined a situation where firms in dire financial trouble could be allowed to suspend all inflation based indexing. Although it did recognise that “moral hazard issues” (3) could be created if companies were tempted to deliberately increase deficits to save on pension pay-outs.
The paper summarised the total deficit of all DB schemes in January 2017 was £197bn, down from £459bn 6 months earlier (2) and predicted that these deficits are likely to shrink for the majority of schemes. “While DB pensions are more expensive than they were when they were set up, many employers could clear their pension deficit if required.”
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.