In the world of finance and business, the traditional corporate pension scheme, particularly the defined benefit (DB) scheme, has held significant influence over British companies, despite most of them no longer accepting new members. However, this dynamic is starting to change, as highlighted in Roula Khalaf’s Editor’s Digest. In 2023, for the first time, defined contribution (DC) schemes absorbed less cash from FTSE 350 companies than the DB schemes.
While DB schemes offer workers the certainty of pensions based on salary and length of service, DC schemes can contribute to UK growth more constructively. Over the past two decades, DB schemes have moved away from equities and towards bonds, providing the government with low-cost funding but limiting the capital available for riskier investments. The financial crisis led to a surge in the cost of meeting DB pension promises due to rising longevity and low interest rates, resulting in FTSE 350 companies contributing nearly £90bn of extra contributions into DB schemes over a 12-year period.
In the five quarters leading up to early 2023, when long-term bond yields rose, DB scheme assets fell nearly a third to £1.2tn. However, their liabilities fell even more, leading many schemes to improve their funding positions using matched assets, longevity swaps, or insurer buy-ins. As a result, fully funded FTSE 350 companies now have an aggregate surplus of £45bn.
The question now arises: who should benefit from these surpluses? Employers who funded extra contributions to repair deficits have a claim on any refunds, but this comes with potential reputational risk. Retirees whose pensions have lost value due to inflation might argue for an increased payout. However, there is also a strong case for improving the pensions of the existing workforce, as nearly two-thirds of households saving into a DC pension cannot expect a moderate standard of living in retirement.
The improved health of DB schemes presents an opportunity to focus on the poorly funded DC pots that replaced them. The pension deficit horror story of recent years underscores the need for caution in distributing surpluses, but it also presents an opportunity for change and growth. For more insights, you can subscribe to Roula Khalaf’s Editor’s Digest.
