Running dry: pension funds hit by US cost-cutting plans

American companies have cut back on both defined benefit and defined contribution pension schemes as a way of cost-cutting through the downturn, thanks in part to action in Washington.

Analyst John Mauldin, famous for his free Thoughts From The Frontline weekly e-newsletter on the US economy, reports a conversation with Standard & Poor’s analyst Howard Silverblatt: he says that US companies’ DB schemes are now under-funded by some $250bn, many having taken advantage of a generous move by former President George Bush to waive the requirement to maintain funding at 92% of scheme liabilities, lowering it to 80%.

If US companies are putting the brakes on DB schemes now that there is a less onerous funding requirement, it stands to reason that they are also going to hammer their payments to DC plans to which don’t have any legal minimum level of contribution.

There has been speculation that UK subsidiaries of American companies could now come under pressure to follow their parent company’s lead and cut back on their contributions to their British employees’ DC plans as well. There is also more than a little concern that other UK employers might also decide to take a leaf out of the US’s book.

Peter Routledge, head of employee benefits at Towers Perrin, says it is now becoming common practice for American companies to suspend corporate payments to the company DC scheme until better times. “The idea, or the promise, is that as and when things get better, the employer will do a ‘catch-up’ payment, or a series of payments,” he says.

Whether the catch-up will be sufficient to offset the earnings lost is unclear, nor is it clear how many companies will be in good enough shape when the upturn finally comes to restore skipped contributions. Employees who have faith in their employer actually making good on the missing payments, could be taking too much on trust. But then, with DC schemes, there is no obligation to make restoration payments ­ apart from any promise the employer might have written into employment contracts ­ for the employer to pay anything at all.

Will British companies follow the American example? Routledge thinks it is more likely that UK companies will opt for more sophisticated options, such as salary sacrifice schemes in which the employee, with the employer’s agreement, gives up a certain percentage of salary that the employer then adds to the employer’s contribution to the DC pension plan.

That way, the employer saves the National Insurance it would have had to pay on the ‘sacrificed’ slice of the employee’s salary, while the employee gets the full tax-free slice paid into a pension. This lowers the overall cost of running the scheme for the employer, while the employee gets a larger contribution to their DC pensions pot.