'A battle royal looms over the defined benefit pension sector'

Advisers, your clients need you. Bat for them to make sure they get their dues in any division of the spoils before they are hoovered up in buyouts and gone to members and employers forever. 

A not insignificant 10mn people are members of DB schemes and 1mn are still accruing rights. Among them, many of your clients looking forward to receiving their annual index-linked pension increases in April.

Some pre-1997 pensions have no indexation and get nothing while others’ increases are capped at 3 per cent or 5 per cent. Meanwhile inflation is eating away at retirement income, especially of the very elderly.

But inflation, although tamed from its heights, is not back in its cage; in the UK it reached a 41-year-high of 11.1 per cent in October 2022. Today, Britain’s annual rate of inflation has remained stubbornly high at 4 per cent for a second month in a row, and the Bank of England has warned that this fall could be temporary, with inflation on the march later in the year.

Yet, for some, particularly the very old, with no inflation protection at all, the loss of such benefits could put them on the breadline. If the inflation rate averages 5 per cent per a year over five years, the reduction in their purchasing power is 22 per cent.

If you want your clients (and their children) to have the best possible pension, start writing to every DB scheme trustee with whom you have a connection.

Tom Selby, head of policy at AJ Bell, explains the impact: “If we had 5 per cent inflation for five years, a £10,000 pension income without inflation protection would be worth £7,738. If we had 5 per cent inflation for 10 years, it would be worth just £5,987."

Most scheme rules permit trustees to make discretionary awards in inflationary periods but many are too timid to do so or have little experience in this area as this issue has not been on their agenda for nearly three decades.

Few pensioners know about these discretionary benefits. Fewer still of their advisers are taking up the cudgels on their behalf to write letters to the trustees.

Some pensioners really need every penny of the extra money – they may have assets but not income. They are not all the rich lazy baby boomers so often ridiculed on social media.

If their pension is not increased, they will have to fall back on state benefits. 

Research for consultancy Broadstone shows many pensioners lose out: “For benefits accrued before 1997, 31 per cent of schemes have capped inflationary increases and a similar proportion (32 per cent) have fixed increases. One in five schemes (21 per cent) do not have any indexation on these scheme benefits."

Only one in 10 schemes offer uncapped increases that keep member payments in line with inflation, and the vast majority of schemes will provide uplifts below the 6.7 per cent consumer price index figure for the year to September 2023.

So, if one or more of your clients has a DB scheme, suggest they write, or perhaps get them to instruct you to write, to their trustees and put the arguments for a discretionary increase.

Setting an exceptional example of good corporate behaviour is the Church of England, which made discretionary increases – in excess of guaranteed increases to clergy pensions in payment in each of 2023 and 2024. The total increases – of 10.1 per cent and 6.7 per cent respectively – match CPI inflation as at the preceding September.

One section of British Airways' pension schemes, the Airways Pension Scheme, has given some eligible members a discretionary Increase every year since 2019 and every year of the difference between CPI and the retail price index with a total 2023 pension increase (including discretionary payment) of 12.6 per cent. It is expected this will continue until 2030 when the Office for National Statistics intends to align CPI and RPI.

While schemes were in deficit there was nothing trustees could do but now there is a colossal £425.4bn surplus at the end of January 2024). This money is up for grabs with total assets of £1,395.2bn and total liabilities were £969.8bn. Much of this is being hoovered up by insurer in mega city deals. 

Indeed, the actuary firm LCP predicts for 2024 volumes of buy-ins/buyouts to five insurance companies will set yet another record of more than £50bn in 2024. Five large companies control 90 per cent of the market in a dangerous over-concentration of assets – their only motive is profit. 

Buyouts benefit insurers 

One of the little understood consequences of buyouts is that hundreds and thousands of DB pensioners may lose out on cost of living top-up discretionary payments as they are usually lost for ever once the scheme is closed and there are no longer any trustees.

The rationale is to protect members from falling into the well-run, well-funded Pension Protection Fund, the pensions lifeboat, which William McGrath, chief executive, C-Suite Pension Strategies, says is an increasingly remote risk: “It has been struggling in recent years to find new joiners as schemes are too well-funded even when their sponsor has failed. It has £11bn in assets above what it needs at present, showing what a profitable business life insurance is.”

The whole buyout process to insurers is far from transparent. McGrath says: “What the difference in value to members actually is and how it is falling over time is not something actuaries actually provide to members. Nobody likes to ask.”

He adds: “In exchange for saving members from a contingent risk, which they know probably does not exist, the trade-off made by actuaries is the loss of existing discretionary benefits and the complete loss of upside. Bottom of the range accrued benefits is enough.

"Working for 'better' even in inflationary times when most increases are capped at 5 per cent is something most trustees have convinced themselves is not part of their job.”

Unless advisers, scheme members and current employees protest, every DB scheme will wither on the vine and disappear. As McGrath says: “When boards of sponsors and trustees know that their actions are being watched, they will sit up straight, focus.”

The danger is, with more professional trustees appointed, sometimes even sole trustees and fewer member trustees on trustee boards, professional trustees may be too conscious of who pays their bills (the employer) rather than acting always in the best interests of the members – their fiduciary duty. 

The Department for Work and Pensions, in its February 23 2024 consultation (Options for Defined Benefit Schemes), says: “As part of this work, we will ensure that the assets held in UK pension schemes can work harder for scheme members, provide a secure retirement and support the growth of the wider economy.”

The consultation recognises that “there is potential for trustees to share surplus with scheme members and sponsoring employers in recognition of their historical contributions”. 

McGrath goes further: “Make 2 per cent per annum of assets available to benefit all stakeholders. Government, led by HM Treasury, has a new mindset on pensions. Out goes “reckless prudence” and “the safest graveyard” in favour of productive assets and intergenerational fairness. Pension consultants and trustees addicted to risk transfers to life insurers are starting to see virtue in 'run on'”.

Stewart Hastie, partner at Isio, the pensions advisory business, says fully funded schemes could create value of 17 per cent of scheme assets over a 10-year period. Sponsors, employees and members could all share in any pay-outs. 

If you want your clients (and their children) to have the best possible pension, start writing to every DB scheme trustee with whom you have a connection and quiz their rationale (if appropriate) for cutting accruals, refusing any discretionary benefit, and far worse, preparing to close the scheme. 

Stephanie Hawthorne is a freelance journalist and former editor of Pensions World