Defined benefit pension costs to reach £10.9bn next year


29 Sep, 2016

Defined benefit pension costs to reach £10.9bn next year

The post-Brexit nosedive in UK bond yields means the cost of contributions to defined benefit pension schemes will increase by over £2bn to £10.9bn in 2017, according to research by Mercer.

The average AA-rated sterling corporate bond yield has plummeted from 3.68% at the end of last year to a record low 1.89%, as reported by Markit iBoxx indices.

This plunge reflects the fact the UK’s growth prospects have declined sharply following the Brexit vote in the EU referendum, causing the Bank of England to implement a splurge of stimulus including a rate cut and bond buying.

This is the metric used to measure pension costs, and as such, the total UK pension deficit and the cost of stemming it have soared.

FTSE 350 companies’ combined pensions’ deficit hit another record high of £189bn last month, as dwindling bond yields drove the deficit up by £50bn in a single month, the biggest monthly widening on record.

The total UK pension’s deficit has ballooned past £400bn since the UK’s vote to leave the EU.

Mercer says the cost of building up defined benefit pension schemes for FTSE 350 firms has risen to 42% of an employee’s annual salary. That’s up from just 29% in March, and 11% in 2008.

The service cost of new defined benefit pensions in 2015 was £7.5bn, but that is likely to increase to £10.9bn in 2017 with bond yields at current levels, Mercer notes.

That amounts to 13% of the £84bn pre-tax profit FTSE 350 companies earned in 2015.

Warren Singer, Mercer’s UK head of Pension Accounting, says the impact is “material”.

He adds, “Brexit has introduced considerable uncertainty on how profit will be impacted by DB pension plans after 2017”.

“The key question is whether you expect 30 years of stagnation in the UK, as implied by the UK bond market. We have seen in Japan this scenario is possible but the Governor of the Bank of England has stated that UK bond yields are distorted by an investor community as a whole that is taking out insurance for extreme risk events,” he continued.

“If employers believe in a low growth world, they may find it unsustainable to allow employees to continue building up new DB pension savings”.

Mercer says the cost of defined benefit schemes is now four times higher than the cost of defined contribution schemes.

Alan Baker, Partner and Head of DB Risk in Mercer’s Retirement Business, added: “Whatever your long term view of bond yields, many employers will want to stop the current bleeding caused by spiralling DB pension costs. For schemes that are still open to contributions, this may well involve closing the scheme and moving to less expensive DC saving plans, yet DC plans are not immune, as the same economic conditions could cut the benefits paid out, causing problems for both employees and employers”.

Today's earlier news - Britain Must Explain Brexit Plan to Curb Uncertainty