So there you are. You’re a member of one or more defined benefit pension schemes related to previous employment and, so far as you are concerned, your pensions in these pretty much “are what they are”.
Your expectation is that these pensions will hold their value, maybe increase a little between now and your retirement, and there really isn’t much you need do to interfere with these.
The private sector pension ‘headache’.
According to a recent article in the Financial Times, there are around 11 million members in private-sector, employer backed defined benefit pension schemes in the UK. The schemes are intended to pay a secure retirement income, for life, usually linked to final salary and rising in line with inflation.
For the employers backing these schemes, however, the scale of the pension liability has become a headache of significant proportions. Across the FTSE 350 as a whole, the gap between the assets and liabilities of the pension schemes is now around £65bn.
Thus, not surprisingly, employers are considering their options with some sense of purpose.
“It’s not that the employers backing these schemes haven’t tried to counter their deficits’, explains PWS Private Client Adviser, Zaheer Hussain. “They’ve made deficit recovery contributions running into the billions, as well as attempting other de-risking plans. But the gap just won’t close. Over time, more and more funds have become enamoured of the idea of switching the basis for calculating increases in benefits to their members, in order to come out with a lower liability. Whereas the majority of schemes have historically used the retail price index (RPI) for determining increases, employers have recognised that switching to using the consumer prices index (CPI) instead can deliver them significant savings.”
The pensions consulting firm Hymans Robertson, as reported in the FT, has calculated that that if all schemes currently basing increases on the RPI were to switch to using the CPI, the combined deficit of private sector defined benefit schemes would be reduced by a hefty £175bn.
So how serious is the index switching ‘threat’?
There are around 6000 private sector pension schemes in the UK, and about two thirds of them base their benefits increases on the RPI.
The latest RPI inflation figure would set benefit increases at 3.9%, whereas using the latest CPI figure would diminish this to just 3%. Professional services firm Punter Southall anticipate that a pension scheme switching from one index to the other stands to make a saving of 10-15% on its liabilities. So if a scheme has a liability of £500m, it stands to advantage itself by £50m to £75m.
The problem for scheme operators, however, is that while some schemes were constituted with the foresight to allow switching between indexes, many were not. The prize to be gained by switching is so worthwhile, however, that many of these employers are now engaged in endeavours to change their regulations through the legal system.
Authorisation, to their dismay, is far from assured. The Court of Appeal has prevented the charity Barnardos from switching to CPI, and BT is still engaged in attempting to gain legal permission to switch those of its members that it has not already moved to CPI.
What would it mean for you if your scheme were to switch?
If you have a pension in a defined benefits scheme, it would be prudent, to say the least, to discover what it might mean for the value of your pension if the employer supporting the scheme were to switch.
“In the Hymans Robertson calculations”, Zaheer Hussain advises, “they estimate that a switch to CPI could cost the average defined benefit scheme member £20,000 in lost pension over their lifetime. Of course for some people, the loss could be substantially greater.”
So what should you do?
As experts in advising clients on pension management, and on switching pensions from defined benefits schemes into personal pensions, PWS takes the view that the urgency of reviewing your position has increased significantly, and you would almost certainly be wise to set wheels in motion.
You need to consider all the options that are available to you, and look at what each scheme you have a pension in is offering you if you remain, compared with the amount the scheme would offer you were you to leave.
Our Advisers can carry out a comprehensive analysis for you, which would compare all options available to you, and consider the pros and cons of each with regard to both your current and future needs.
Talk to your PWS Client Adviser about the potential impact of ‘RPI to CPI’.
If you have a defined benefit pension in the UK and are concerned, or wish to gain more information on what impact a switch from RPI to CPI could have on the value of your pension schemes, please contact us.
We will be pleased to advise you and run an analysis on your existing schemes compared with the options that are available and, potentially, more beneficial.
It is important to understand that not all advice and analysis that we give will result in a recommendation to transfer. For many people, transferring will be the right option. However for others, remaining in their current scheme will provide them and their family with the benefits they are looking for from their pension.
This is why it is so important to understand all the options that are available to you as a UK defined benefit pension member.