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Companies could have to top up final salary pensions by as much as £100bn, new research claims

Out-Law News | 16 May 2012 | 3:11 pm | 2 min. read

Companies could have to pay out more than £100 billion to make up pension scheme deficits over the next three years, according to new research.

In its third annual survey of more than 170 trustees and pension professionals, risk management company Pension Corporation found that 37% of trustees expected to negotiate an increase in contributions from their schemes' sponsors, with half of those seeking more than a 10% increase. Almost half of all trustees expected funding levels to have fallen since the scheme's last valuation.

Despite pension schemes receiving more than £80bn in deficit reduction payments from their sponsor employers over the last three years, Pensions Corporation said that its research showed that deficits had not decreased in reality. "Employer contributions have mostly been used to compensate for further underperformance of assets against liabilities, with little progress being made to reduce deficits," it said.

Trustees are required by law to ensure that a pension scheme has "sufficient and appropriate assets to cover its technical provisions". They must obtain a written valuation of assets and technical provisions each year, although full valuations need only be done once every three years if actuarial reports are obtained for the intervening years.

David Collinson at Pension Corporation said that a combination of misguided legislation, poor investment performance and the overall economic environment had "combined to create a perfect storm" in the pensions sector.

"The report confirms that defined benefit occupational pension schemes are still struggling with funding," said pension law expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com. "This is frustrating for employers who have already diverted money from their businesses to their pension schemes to try to plug deficits."

Last month the Pensions Regulator issued new guidance indicating that it expected employers to carry on funding schemes in accordance with plans already in place unless there had been a change in the company's ability to pay. The regulator warned that although it would give struggling companies "greater breathing space", it expected employers who were "substantially underfunding" their pension schemes despite being able to afford higher contributions to use cash they had set aside for other purposes, such as capital expenditure or making dividend payments, to make up the difference.

The Pension Corporation said that this could amount to UK companies putting 13% of their cash holdings towards pension scheme deficits.

"The Government talks of introducing a 'defined ambition' pension system," said Collinson. "The reality for many members of private sector DB schemes is that this is exactly where they are today. What many in the pension system fail to realise – or worse are afraid to say – is that those members who hope to start drawing their pension in the next few years or decades will not necessarily be getting what they were promised today."

Industry body the National Association of Pension Funds (NAPF) has claimed that the combined value of the final salary and other defined benefit schemes it monitors has dropped by a further £90bn since the Government began its second wave of quantitative easing (QE) last October. Defined benefit schemes promise a set level of pension once an employee reaches retirement age no matter what happens to the value of the underlying investment, and are particularly affected by QE because they tend to invest heavily in Government 'gilts', or securities.

The majority of the extra money generated by the QE process has been used to buy gilts, pushing up their prices and resulting in the 'yield' – or return – on those gilts falling as a percentage of the price. Lower gilt yields and long-term interest rates also affect a formula known as the 'discount rate', which is used by a pension scheme actuary to calculate the cost of providing all the benefits currently promised during the scheme's regular valuations.