Pension Deficits Showing a Reduction

Pension deficits for UK public and private companies appear high up the agenda in Director Board meetings. Following changes in the way both companies and pension schemes disclose the pension deficit (or surplus) in their annual accounts, the management of any deficit is becoming even more important, particularly for companies where there is pressure to continually increase value for shareholders.

A pension deficit occurs where the future liability to pay pension benefits exceeds the value of the pension assets. Where a deficit has occurred, there is pressure on an employer as they then must develop a recovery plan with the Trustees of the Pension Scheme to reduce this deficit over time. This ultimately results in an additional pension contribution cost for the company.

Pension Pot

Pension deficits only occur in defined benefit (“DB”) schemes, where the annual benefit to the retiring member is based on a calculation derived from their future salary. This differs from a defined contribution scheme where the contributions by the member and the employer accumulate into a “pension pot” which can then be used to create a monthly pension benefit once the member retires.

New figures indicate that there has been an improvement over the last 12 months in the funding position of all UK private sector schemes. The table below shows the reduction in the pension deficit between 2017 and 2018 for UK DB pension schemes (source: JTL Employee Benefits Jan 19).

Deficit Table

Despite a material decrease in the deficits, there has been no change to the funding level of all UK defined benefit pension schemes.

Due to political uncertainty, specifically from Brexit, and the wider weakening global economic environment, there has been some volatility in financial markets during 2018.

The impact of a significant drop in asset prices from a global downturn or recession or rising interest rates during 2019/20 could further put pressure on pension schemes and their employers if pension deficits widen again. We have seen a recovery in global equity prices since the significant pull back in Q4 of last year, however this may just be a “bear-market” rally and a much faster and deeper decline may occur during 2019. This impact, resulting in lower pension assets, may be somewhat offset by the transition to more of a pension liability matching investment model by Trustees. However, the future management of pension liabilities is still an issue if Companies cannot afford to pay more or, as we have seen over the past few months, companies get into financial difficulty and move into an administration or liquidation scenario. This is where the role of the Pension Protection Fund will be tested as pensioners seek to maintain their contractual pension benefits.

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