Final-salary schemes face a squeeze

Parliament is set to consider the funding problems faced by the UK's defined-benefit (DB) pension schemes as part of a new inquiry, headed up by Frank Field, chair of the Work and Pensions Select Committee. The inquiry, which is due to begin in the autumn, will offer "radical solutions", says Field. It seems likely that this could include substantial changes to the benefits that many DB scheme members have been promised.

About 11 million people are members of 6,000 traditional DB schemes also known as final-salary schemes which pay a pension based on the member's salary at retirement and the number of years they have been in the scheme. However, the combination of rising life expectancy for scheme members and low interest rates on government bonds means that many of these schemes now have liabilities that far exceed their assets, and closing this gap has become an increasing burden on the firms that are responsible for funding them.

The total deficit across all private-sector DB schemes increased to £310bn at the end of May, up from £255bn at the same point in 2015, according to new research from JLT Employee Benefits. The deficit for DB schemes run by FTSE 100 firms alone has grown from £80bn to £100bn over the same period.

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The Committee is yet to say what solutions it proposes. Certainly, there are no easy fixes for as long as interest rates remain low and regulations continue to push schemes to invest more of their assets in low-return government bonds. However, plans to allow British Steel's DB scheme to cut benefits for its 130,000 members to reduce its £700m deficit give an idea of what we can expect.

The British Steel proposal involves pegging annual benefit increases to the consumer price index (CPI). At present, this scheme and most other DB schemes link their payments to the retail price index (RPI), which is generally higher than the CPI. Doing this could cut billions of pounds from pension funds' long-term liabilities.

Retrospectively changing benefits that have already been accrued from RPI to CPI isn't allowed under the Pensions Act 1995. Critics have said that changing the law to allow this to happen for British Steel would "open the floodgates" to other firms who want to abandon their pensions promises. Rightly or wrongly, this now sounds increasingly likely.