DC growing despite perceived drag of DB funding

Defined contribution (DC) pension schemes are “coming of age” in the UK, despite evidence that defined benefit (DB) pension schemes still represent a major burden for the country’s largest companies.

Investment consulting firm Willis Towers Watson (WTW) published a report his morning claiming that DC schemes have become the “new normal”.

The report, which focused on the provision of DC pensions by FTSE 350 companies, found that 98% of new employees at companies in the index join DC schemes.

In contrast, DB pension scheme deficits at FTSE 350 companies were £191bn (€222bn) at the end of last year, according to JLT Employee Benefits. This is more than twice the level at the end of 2015. Funding also dropped between 2015 and 2016, from 88% to 78%.

Deficits are susceptible to volatility in UK gilts, but have been generally growing as liabilities have grown faster than assets in recent years. Companies discount liabilities on the basis of high-grade corporate bonds.

Although it is difficult to estimate the aggregate level of yearly contributions to DB schemes, WTW suggested that the UK’s largest companies may be paying twice as much to reduce DB deficits, compared to the amount they contribute to fund DC schemes.

This was despite the sharp decline in the share of companies still offering DB schemes to new or existing employees, as well as the planned increases in statutory DC contribution rates under auto-enrolment legislation.

The WTW report found that 54% of FTSE 100 companies still offer DB pensions to existing employees, down from 84% in 2009. Only 27% of FTSE 250 employers are keeping DB schemes open to existing employees. As much as 37% of FTSE 100 companies have closed DB schemes to new accrual, while 42% FTSE 250 companies have done so.  

Median annual contributions to DC schemes at FTSE 100 companies were £18m in 2016, increasing almost four times over since 2009. The corresponding figure for FTSE 250 companies is £6m, compared to £2m two years ago.

Median DC plan assets at FTSE 100 companies were £201m at the end of last year, showing a large increase from £92m at the end of 2015. This was partly explained by the appreciation of non-sterling assets due to the decline of sterling. Median DC plan assets grew from £35m at the end of 2015 to £75m at the end of last year.

Richard Sweetman, senior consultant at Willis Towers Watson, said: “While the ongoing cost of DB will remain a major issue for employers, this survey provides hard evidence of the speed with which DC provision is establishing a dominant role in the UK pensions landscape.”

However, other recent surveys suggested that UK corporates were struggling to meet the requirement commitment to develop DC pensions, as they weigh important decisions on how to fund DB deficits.

JLT recently said that dealing with legacy defined benefit (DB) pension schemes represented a “drag” on developing adequate DC offerings.

Consultancy firm Hymans Robertson found that only 9 out of 100 UK trustees focused on the true cash flow position of their schemes, while funding gaps remained the main concern.

The UK government last week launched a green paper on how to ease the burden of DB schemes on employers, setting the scene for reforming the provision of DB pensions.

The WTW study highlighted that, although FTSE 350 companies are generally happy with their commitment to DC pensions, there is increasing attention on improving DC offerings.

Sweetman said: “We also see an appetite to look at ways of making arrangements work better, particularly in identifying the best vehicle for delivering DC (as seen in the emergence of master trusts), restructuring contributions to allow wider savings options, improving investment strategies, and introducing enhanced member information and support around adequacy and retirement options.”