Defined benefit pension schemes could cut their collective £1tr deficit by £350bn - or more than a third - by reducing pension increases to the statutory minimum, pension consultancy Hymans Robertson has claimed.
However, this would see members take on average a £32,500 pay cut over the course of their retirement, the firm calculated.
The comments were made in the context of a Work and Pensions Committee inquiry, currently in the submissions phase, that will explore solutions to the UK’s underfunded DB sector.
The committee chair Frank Field told FTAdviser in May that one solution to the funding crisis could be to reduce increases so that members still received a “good boost”, but one that “may not be all that they wanted”.
According to Hymans Robertson, around three quarters of DB schemes link their annual pension increases to the retail price index (RPI), which currently stands at 1.8 per cent.
The remainder link increases to the consumer price index, currently at 0.6 per cent.
But while most do link to RPI, there is nothing in the law that insists they do.
According to the Pension Advisory Service, increases on pensions built up after 1997 must be linked to CPI to an upper limit of 5 per cent (or 2.5 per cent for those built-up after 2005).
For benefits accumulated before 1997, there is no statutory minimum at all, other than on contracted-out state pensions known as guaranteed minimum pensions (GMPs).
That would mean if all schemes limited themselves to statutory increases, some members would receive no annual pension increases, some would receive partial increases, and the rest would receive increases linked to CPI.
Hymans Robertson also calculated that £175bn would be shaved off the £1tr deficit if all increases were linked to CPI rather than RPI. That would ensure that all members still received some increase, and would reduce average benefits by £20,000, rather than £32,500.
While there is no law stipulating schemes must link increases to RPI, many schemes have committed to doing so in their rules, and therefore have a legal obligation to do so.
Hymans Robertson’s head of corporate consulting John Hatchett said linking all increases to CPI would end “scheme rules lottery” and increase affordability. But he added that “politically and morally it would be difficult to make a case for worsening future indexation” for schemes that were fully funded.
Mr Hatchett also aired the possibility of abolishing statuory increases altother for a limited time for schemes that were in “dire straits” - a policy he called “conditional indexation”. He said such a policy would need “watertight safeguards” and should only be available to “genuinely stressed schemes”.
Mr Hatchett concluded: “We need to remember that the majority of DB schemes will be able to pay benefits in full. Any changes to the regulatory regime should not penalise the large majority of well-run schemes to deal with the challenges faced by a minority at the edges.
“Given the flexibilities in the current integrated risk management funding regime, deficit funding should never become the straw that breaks the sponsor’s back. Nonetheless funding and investment strategies will be under more strain than ever before in the current low yield environment.”
The deadline for submissions to the Work and Pensions Committee is Friday 23 September.
james.fernyhough@ft.com
