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Report claims new economic normal, of permanently lower growth and interest rates coupled with a rapidly ageing population means urgent action is required to prevent more Defined Benefit scheme collapses like BHS

A new report launched today by the International Longevity Centre – UK (ILC-UK) claims that the weak growth and low returns on ‘safe’ assets such as government bonds experienced since the financial crisis may represent the ‘new economic normal’, meaning that DB pension deficits will remain high with potentially negative consequences for wages, firm profitability and retirement income.

  • In the last decade, the asset allocation of DB schemes has dramatically shifted, from fixed interest bonds representing 28.3% of investments in 2006, to 51.3% in 2016 [1]
  • Between 1989 – 2007 average real returns on UK government bonds were 4.1%. Between 2008 – 2016 the average was only 0.45% [2]
  • While some commentators maintain bond returns will increase, bond yields at home and abroad have been consistently falling since the 1990s, way before the financial crisis of 2008 [3]
  • As of October 2016, 80.6% of DB schemes were in deficit [4]. Between 10-17% of these schemes are at serious risk of default [5].
  • New analysis finds that if the money used to plug private DB pension deficits between 2000 and 2015 had been redirected towards wages, average salaries could be £1473 higher

The End of the Beginning? Private defined benefit pensions and the new normal’, claims that the ‘new normal’ economic conditions of lower productivity and lower returns on fixed interest bonds means we cannot simply wait for returns to improve in order to solve the DB deficit crisis.

The ILC-UK’s report argues that weak growth and low returns on bonds have been highly persistent since the financial crisis. Up until now this has been portrayed as a temporary problem which will eventually be reversed. But the authors argue that current economic weaknesses could be structural and that we may be in the midst of a ‘new normal’ where the trajectory of growth is permanently lower.

Such a view is underpinned by analysis of three centuries of data showing a dramatic slowdown in productivity since the turn of the century. Ultimately the high growth, high returns world of the middle to late period of the twentieth century may turn out to be the true anomaly.

Source: ILC-UK calculations and Bank of England, Three Centuries of Macroeconomic Data.


Notes: 50 year annual average apart from 2001-2015.

The report argues that the private sector DB world faces a very real problem whereby persistent deficits will continue to pose challenges for all stakeholders:

  • Firms will have to continue plugging pension deficits,
  • Pensioners may have to take haircuts on the level of pension income they were originally promised.
  • Employees may have to forgo wage rises and larger employer contributions to DC pension schemes.

New analysis conducted for the report also finds that if between 2000 and 2015, the money that was used to plug private defined benefit pension deficits had instead been redirected towards wages, average salaries could have been £1473 higher by 2015.

The report concludes that the regulatory regime should better take account of both member’s interests as well as the long term interests of the firm and its employees. In addition, the report argues for consolidating schemes to allow for sponsors and scheme members to enjoy better value, which may alleviate some of the financial pressures associated in running a DB scheme.

Ben Franklin, Head of Economics of Ageing, ILC-UK said, “Adverse economic conditions and an unprecedented demographic shift towards an ageing society has put the sustainability of private sector DB schemes in doubt. Despite schemes being closed to new members, increased life spans and the persistence of a low interest rate environment means the issues surrounding private DB will not abate any time soon. We hope this report can kick-start a debate that leads a set of socially and economically acceptable solutions to the challenge. None of this will be easy, but simply hoping for interest rates to return to normal is futile.”

Jennifer Donohue, Head of Global Corporate and Transactional Insurance, Ince and Co LLP said, “The problem has been growing in seriousness for over a decade and we have assisted some of our clients to avert difficulties in the face the increasing pension deficit scourge. However the issue is exponentially growing as the call on the funds of defined benefits schemes tightens and the yield on investment continues to fail. The effect of this pincer like movement will affect numerous companies and financial institutions.Behind the mathematics ‎is a UK population continuing to rely upon funds that may run out often well before the promise of a “retirement pot” can be kept. For Ince this report is crucial to raising factual awareness the hope that it will result in intervention, whether by governments, companies, scientists or other stakeholders. A Nelsonian approach is no longer appropriate. We commend this report as a ground breaking analysis of the significant challenge ahead for the UK population and economy”

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