Exit strategies becoming ever more crucial. Research from JLT Employee Benefits (“JLT”) found that shortfalls in UK private sector defined benefit (DB) pension schemes have doubled since 2006, despite employers making contributions worth £160 billion.
This is primarily the consequence of Increasing life expectancies and low expectations of future investment returns. It’s estimated that DB scheme assets have grown from £0.65 trillion in 2006 to £1.3 trillion in 2015 whilst liabilities* have risen from £1.1 trillion to £2.1 trillion. This means that, collectively, deficits have doubled from £0.4 trillion to £0.8 trillion. On a per person basis, this is the equivalent of £73,000 per DB scheme policy holder (including all active, deferred and retired members).
A £3.6bn funding gap to fill
The total actual cash flows that schemes have to pay out to members in the future is estimated to be £3.6 trillion. With current assets worth £1.3 trillion, there is a gap of £2.3 trillion – 1.2 times UK GDP (£1.9 trillion in 2014) – that has to be closed by a combination of cash contributions from the sponsoring employer, future investment returns and a reduction in liabilities through de-risking exercises.
If low interest rates became the ‘new normal’, then even with projected investment returns companies would need to pay £220 billion in contributions over the next decade just to get them back to the deficits levels of 2006. JLT explains that improvements in life expectancy were partly responsible for the increase pension scheme. Longevity at age 65 rose by approximately 2 years between 2006 and 2015, adding £135 billion to pension scheme liabilities.
Murray Wright, actuary and consultant at JLT Employee Benefits, comments: “Our analysis highlights that DB pension schemes across the UK should take a serious look at how they plan to close deficits. Pension schemes cannot continue to follow the same strategies that have been used for the last 10 years. There is a £2.3 trillion cashflow shortfall that needs to be met by a combination of contributions from sponsors and future investment returns. They also need to consider how the £2.3 trillion target itself can be reduced through liability management exercises. Trustees and employers should ensure they are using all of the levers available to them to stop pension shortfalls from spiraling out of control.”
* Liabilities are measured on buyout assumptions.
The number of pension schemes fell from 7,751 at 31 March 2006 to 5,945 at 31 March 2015. To allow for a like for like comparison JLT has adjusted historic figures to allow for schemes that have wound-up, merged, entered PPF assessment or transferred into the PPF.