Merryn's Blog

The final salary pension has strangled investment

Companies are more concerned with meeting their pension obligations than investing in their businesses.

One of the biggest conundrums in the UK market at the moment is the failure of UK companies to invest.

Last Saturday, Stephanie Flanders, now of JP Morgan, took to the pages of the FT, to note that "investment now accounts for a smaller share of the UK economy than at any time in the last 30 years and is five percentage points of GDP lower than in the US."

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

She reckons that can change if businesses "have confidence that the UK is on the road to recovery." We wonder if it is that simple.

Anyone who found their eyes wandering to the words in the column next to Stephanie's that day might have found evidence that it isn't. That one was about Detroit and referred to the "astonishing" fact that the bankrupt city still offers defined benefit pension plans "costly pensions that are determined in advance by employees earnings."

Advertisement - Article continues below

In the UK, we know these mostly as final salary pension schemes what you get depends not on how much money you have saved and the investment returns you have made on them, but on your salary at retirement. The key here is that these are costly, (very, very costly), and that an awful lot of the UK's older companies still run them.

With that in mind, consider the results just out from a survey by the CBI and Standard Life. It covered 226 chief executives and board members in companies with £360bn of pension funds to cope with.

84% of them are worried about the ongoing funding of the scheme. 88% are concerned that their contributions to their funds are going to have to rise when they make their next funding agreement with the trustees of their pension funds. 70% of them say that the cost of their defined benefit schemes is having an "impact on business investment". That number rises to 78% if you only look at manufacturers.

226 companies might not be that many, but these results are still shocking and chime well with several conversations I have had recently with business owners.

They feel that they can't invest. Why? Because they either have to come up with more cash to fund their pension schemes or they are worried they will soon have to. How did we get to this point?

Neil Collins summed it up pretty well in a recent FT column. In the good times, huge extra obligations were heaped on to the schemes "almost casually" by government after government (1995 being a turning point see this bit of the pensions act).

Advertisement - Article continues below

Then long-term interest rates collapsed, pushing up the present value of the future liabilities: the lower a return the market is giving you, the more money you need in the first place to be sure of being able to pay your pensioners later.

So, the more interest rates fell, the more pension funds fell into technical deficit and the more money directors were obliged to shift from investment to pension funding* (a 1% fall in the discount rate can raise your liabilities by over 20%).

By October this year the defined benefit pension liabilities of the companies in the FTSE 350 was equivalent to some 35% of the market capitalisation of those companies. That's a record high by a long way.

Regular readers will know that we think there are many reasons to normalise interest rates. This is another one. Super low rates are supposed to encourage companies to invest. But if they have a defined benefits pension scheme, it does precisely the opposite. That's bad for all of us. The less investment we have, the less likely we are to get the sustainable recovery we so badly need.

*Many directors for firms with pension deficits (that's over 80% of those with defined benefit pension schemes) will tell you that they feel that the pension trustees rather than them actually run their companies they and the trustees are supposed to "work together to manage and balance the risks to their business and the scheme".

But rare is the pension trustee who considers it a good idea to invest spare cash (something that is obviously risky) rather than shovel it into the pension scheme. The pension regulator does have a relatively new objective to minimise the adverse impact on a business from its deficit, but as the CBI puts it, this "has yet to have a positive impact."




Beyond the Brexit talk, the British economy isn’t doing too badly

The political Brexit pantomime aside, Britain is in pretty good shape. With near-record employment, strong wage growth and modest inflation, there is …
17 Oct 2019
Personal finance

Companies cut back on their pensions bills

Britvic is the latest firm hoping a cheaper inflation index will cut pension costs. David Prosser reports.
28 Aug 2019

Good news for pensions savers from HMRC

HMRC has withdrawn its appeal over breaches of the pensions lifetime allowance.
28 Jun 2019
Personal finance

Don’t miss the pensions deadline

There are just five weeks left in the 2018-2019 tax year, so make sure you’ve made full use of your allowances.
6 Mar 2019

Most Popular


Here’s why the Federal Reserve might print more money before 2020 is out

The Federal Reserve wants to allow US inflation to run “hot” for a while. But that’s just an excuse to keep interest rates low – and possibly print mo…
10 Feb 2020
Investment strategy

The secret to avoiding being panicked out of your portfolio

With the coronavirus continuing to occupy headlines, investors still aren’t sure how to react. But the one thing you mustn’t do is panic. Tim Price ex…
11 Feb 2020
Investment strategy

Just five assets matter for investors. Here's what they are

Every investor’s needs are different – but most can be met by the right combination of five investments
11 Feb 2020

The rare earth metal that won't be a secret for long

SPONSORED CONTENT – You can’t keep a good thing hidden forever; now is the time to consider Pensana Rare Earths and the rare earth metals NdPr.
31 Jan 2020