The UK’s largest private-sector pension scheme has blamed the pandemic for its deficit more than doubling to £12.9bn, a decline in fortunes likely to be watched closely by the thousands of employers offering similar secure retirement plans.
Experts warned that if the pandemic continued, companies badly affected by the crisis that are still offering such “defined benefit” pensions, which give retirement payments based on a person’s salary and service, might have to close their schemes and place workers on riskier plans or demand higher contributions.
The £66bn Universities Superannuation Scheme, the main pension fund serving the university sector, on Wednesday reported a deficit of £12.9bn as of March 31 this year, up from £5.7bn a year earlier.
Since March 2019, the 400,000 members, including lecturers and librarians, and 350 university employers, have twice had to put more cash into the scheme, in October last year and April this year, but there has been no increase in benefits.
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USS attributed the sharp rise in the fund’s deficit to reductions in interest rates over the year and the “devastating” impact of coronavirus on global markets.
“Even before Covid-19, historically low interest rates, increased life expectancy, greater regulation, and volatile financial markets had already made promises of a set retirement income for life more expensive,” said Bill Galvin, USS group chief executive.
“The depth of the economic shock brought about by the pandemic has highlighted the long-term challenges facing open DB pension schemes like USS.”
The USS is now performing a deeper assessment of the fund’s finances, or formal valuation, which will determine whether members, and employers, will have to pay more to maintain their current retirement benefits.
But the scheme’s managers warned that the damage to its finances from Covid-19 was likely to have worsened since the funding snapshot in March, with further contribution increases on the cards.
“Monitoring of the key financial assumptions, interest rates and expected future investment returns, in particular, would suggest it is unlikely that the current (contribution) rate will be adequate,” the USS said.
There are around 550 defined benefit schemes still open to new joiners, with some 1.1m members, offering pensions which pay a secure retirement income for life to the member and a surviving spouse. Another 4,950 schemes have been closed to new members because of rising costs and increased life expectancy but still offer the same benefits to existing members.
Central bank measures to stimulate spending by households and companies as the coronavirus crisis deepened, including lowering interest rates, have had the effect of driving deeper holes in defined benefit pension scheme finances.
Lower gilt yields today suggest a lower return in the future. So the lower gilt yields go, the bigger the liabilities, or the expected cost of meeting future pension promises
This month Mercer, an actuarial firm, estimated the accounting deficit of defined benefit pension schemes for the UK’s 350 largest listed companies had increased from £72bn at the end of May 2020 to £90bn on June 30, driven by falling yields and rising inflation.
“Pension schemes have to make an assumption about what investment return on their assets may be in the future and one of the things that feeds into that assumption is long-term interest rates, or gilt yields,” said Paul Hamilton, partner with Barnett Waddingham, a firm of actuarial consultants.
“So lower gilt yields today suggest a lower return in the future. So the lower gilt yields go, the bigger the liabilities, or the expected cost of meeting future pension promises.”
When DB schemes close, workers are typically shifted into “defined contribution” plans, where the pension is not backed by the employer. These pensions are affected by movements in the underlying investments held, but unlike DB pensions, the employer does not have to set money aside for the cost of pensions running decades into the future, with the value of these promises sensitive to movements in interest rates.
Experts said the malaise afflicting the USS would not necessarily be replicated across all defined benefit schemes, particularly those which had fully insulated, or hedged, against interest rate falls.
USS said it had hedged a proportion of inflation and interest rate risk in respect of accrued pensions, which had “dampened the impact of interest rate movements.”
“Everyone who has hedged would have been protected against the recent falls in interest rates to some degree,” said Hemal Popat, director of investments with Mercer. “Where there has been a material deficit it is likely that company contributions will go up at some point, at the next valuation.”
Earlier this year, The Pensions Regulator noted that the impact of Covid-19 on schemes would be mixed, with some seeing their position actually improving owing to their investment strategy.
However, experts warned that once Covid-19 had passed, the pressures on DB schemes that had predated the pandemic, such as rising life expectancy, would still press hard on the long-term prospects of the retirement plans.
“The Pensions Regulator would prefer schemes to be better funded and their job is to pressure for that to happen,” added Mr Hamilton, of Barnett Waddingham. “However, due to the pressure on employers from Covid-19, it remains to be seen how the regulator will respond.”
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