Approximately 3 million Britons out of the estimated 11 million who rely or will rely on private sector defined benefit pension plans for retirement income will have only a 50% chance of receiving their full benefits, according to a report from the Pensions and Lifetime Savings Association (PLSA).
The findings come from the final report of the PLSA’s Defined Benefit Taskforce “Opportunities for Change,” which offers a range of options to help pension plans facing the challenges of underfunding, weak employer covenants, and lack of scale.
According to the report, more than 4,000 out of the 6,000 defined benefit plans in the UK are in deficit. It also found that defined benefit pension deficits total more than £400 billion, despite employers spending £120 billion over the past 10 years in special contributions.
“While most schemes will be able to reach a sustainable funding position by drawing on their resources and the financial strength of their sponsoring employer, this won’t be the case for all schemes,” said the report. “Many employer covenants are under pressure and 3 million members in the weakest schemes only have a 50:50 chance of receiving their full benefits.”
The report said that employer covenants, which is the ability of the employer to meet its obligations, are the solution to underfunding, and it is likely that most underfunded plans should eventually reach a sustainable funding position by drawing on the financial strength of their sponsoring employer.
“But some will not,” said the report. “The kinds of sectors which were thriving when DB schemes were established and where current DB liabilities are disproportionately concentrated, such as manufacturing, have often struggled to deal with the new world order.”
One of the main problems the taskforce found is that the defined benefit system is too fragmented with too many small, sub-scale plans. It said that the proliferation of smaller pension plans creates problems for sponsors, trustees, and regulators, and that smaller plans are generally characterized by poorer governance standards than larger ones.
“They also struggle to leverage economies of scale and attract the quality of skills needed to operate and invest efficiently,” said the report. “They can also find it harder to navigate the highly intermediated nature of the UK pensions system.”
The PLSA’s taskforce investigated a range of potential options that could help plans improve their performance, as well as the probability of members seeing their benefits paid in full, and offered three main recommendations:
- A New Chair’s Statement for Trustees – Require plans to produce an annual statement to demonstrate that they are operating in line with best practices in areas such as governance, investment performance, and cost transparency.
- Standardize and Simplify Benefits – “The UK’s 6,000 DB schemes manage tens of thousands of different benefit structures: costly to administer, confusing to members, and a barrier to improving efficiency.” The PLSA said defined benefit plans would benefit from government action to make it easier to simplify these structures while retaining the full benefits for each member.
- Superfunds –The report proposes creating so-called ‘superfunds’ that would consolidate the assets and liabilities of multiple pension plans. PLSA said its research indicates this would be affordable and attractive to many employers and trustees.
“Our proposals have the potential to transform the industry, helping to ensure more members get their full benefits,” said Ashok Gupta, chair of the PLSA DB Taskforce. “The industry and government need to grasp this opportunity and tackle serious flaws that threaten the security of people’s retirement.”