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Pensions challenges ahead

PENSIONS DEFICITS are creeping up, auto-enrolment continues to dominate the agenda, and the government continues to churn out pension-related legislation like a 24-hour processing plant. The likes of Karren Brady and Theo Paphitis [pictured] have been roped in to feed the promotion machine. No wonder FDs are feeling fatigued by it all.

Fatigued they may be, but experts are predicting 2013 will be another challenging year for company pensions schemes. Like a harbinger of the difficulties the next 12 months will have in store, even the best monthly stock market performance for 24 years failed to stop defined benefit (DB) pension deficits increasing in January.

The FTSE 100 recorded its best start to the year since 1989, adding £96bn to the value of blue-chip companies over the course of January. Pension deficits did not respond accordingly. Financial planning group Towers Watson estimates that the combined pension deficits of FTSE 100 companies, as calculated for publication in their annual accounts, was £38bn at the end of January, up from £35bn at the end of December.

“Companies began the year expecting that the retail price index would be changed in a way that would reduce future payouts from final salary pension schemes. They had a rude awakening on 10 January when the national statistician announced that this would not happen after all,” explains John Ball, head of UK Pensions at Towers Watson.

Company pension deficits remain one of the core risks capable of bringing down an otherwise well-run business. Yet it remains only one of many challenges with which FDs will be grappling this year. For one, funding negotiations are going to be challenging. If 2012 was thought to be a terrible year for negotiating DB funding agreements, the bad news is this year will be worse.

“It will be hard for the regulator to repeat its argument that most deficits can be accommodated by making modest tweaks to existing recovery plans,” says Ball. “What the numbers will look like precisely and how they are dealt with may depend on whether the government changes the rules before negotiations kick off.”

Employers should also expect to be forced to review the pensions they offer, adds Ball. The government is expected to publish a white paper on state pension reform which will propose ending the option for defined benefit schemes to contract out of the state pension.

Ball expects the change should be signalled this year, though is unlikely to come in until 2016 or thereabouts. “When it does, employers who still have staff in their DB schemes will have to choose between cutting back benefits and swallowing more of the cost themselves – something to which most have not yet given much thought. Offsetting the lost national insurance rebates with higher employee contributions could be tricky because members will have to pay more national insurance too,” he says.

Providing options

While government reforms are expected to tempt more and more companies to close their DB schemes to new members and transfer employees to a defined contribution scheme [see page 39], employers will still have to provide DB scheme members approaching retirement with flexible options.

Choices include reshaping pensions to have different levels of spouses’ benefits or higher initial pensions with lower annual increases, explains Fiona Matthews, head of retirement risk management solutions at Towers Watson: “The outcome may lead to lower cost and risk for the employer and, for some members, the value of taking more income now may have a big benefit.”

Nevertheless, 2013 is likely to see a significant increase in the number of DC pension scheme members considering an alternative to traditional annuity purchases. “The combination of low gilt yields and the impact of the European Gender Directive means that annuity rates are pretty much at an all-time low, with male scheme members particularly badly hit,” says Jackie Holmes, senior consultant at Towers Watson.

Just as in 2012, auto-enrolment will continue to dominate the UK pensions agenda. The auto-enrolment opt-out rates will dramatically undershoot the 30% estimates that have been predicted as inertia proves to be a strong force. This will create concerns as capacity dries up and providers hike up prices.

Dealing with employees who opt in and then opt out of the enrolment process could turn the process into a personnel rather than pensions issue. For small companies, this could prove a particular challenge.

“Some companies may have to employ extra people to manage the process,” explains Jack McVitie, chief executive of the LEBC Group.

In addition to this, the effect of the Retail Distribution Review will see further consolidation in the advisor market. “RDR makes it more difficult for IFAs to cross-subsidise advice. They will have to charge more. That’s just the mechanics of it,” concludes McVitie. ?

 

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