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Breaking down the barriers to DB closure for small schemes

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By Steve Deverell-Smith | March 11, 2021

What is the reality for most small DB schemes? Steve Deverell-Smith plots the course forwards.

In his November article: DB or not DB, what is the solution my colleague, Mark Daniel, highlighted the innovations we have helped design and implement over the last couple of years for defined benefit (DB) schemes still open to accrual. This has included Collective Defined Contribution, pension allowances and variable accrual rates.

Whilst these benefit reforms are out there, the stark reality is that although they offer a genuine opportunity to be creative for the largest/strongest employers, most companies with DB schemes open to accrual will need to take a different path if they are to manage the escalating costs and risks.

So what have the others done?

Over the last 12 months, there has been a notable acceleration in the number of DB schemes with small active populations closing to all future accrual. Whilst leaving these schemes to “wither on the vine” was hoped by many to be a viable solution, that hasn’t played out in practice. Increasing costs, risks and inequity, coupled with recent global events, has led many Finance and HR Directors to the (perhaps inevitable) conclusion: closing off the DB scheme to future accrual is the only option.

Most companies with DB schemes open to accrual will need to take a different path if they are to manage the escalating costs and risks.”

Steve Deverell-Smith
Director

Why now?

For these companies, the DB scheme had typically been closed to new hires for a number of years and had therefore become a privilege only afforded to a reducing minority in the business. These schemes were also expensive to run – lacking much of the scale achieved by their larger comparators, meaning innovation of the ilk described above was simply not an option. They also presented a disproportionate risk and time-cost to business-as-usual activities and created a huge disparity between the cost of financing future service benefits across the workforce – with the cost of providing DB pensions typically four-times higher than the cost of providing a median DC benefit. Indeed, some organisations found they were spending more than 50% of their pension budget on less than 20% of their employees! This has simply been exacerbated by the last 12 months.

Some organisations found they were spending more than 50% of their pension budget on less than 20% of their employees!

Do obstacles to change still remain?

Historically, “cost”, “PR” and “poor timing” were commonly cited amongst the top three barriers to approaching the closure conversation. However, recent pressures have forced employers into looking at these issues through a different lens. In particular:

  • With costs of maintaining an open DB plan continuing on their upwards trajectory, the costs associated with consulting on and implementing change are commonly now recovered in only a handful of months. Having supported a number of exercises covering small groups of employees (e.g. < 20, < 30 and < 50) in the last 12 months, this is true even for exercises impacting only a handful of people.
  • In the current environment, the PR risks of inaction can commonly be as great as, if not greater than, those associated with taking positive action. With over 1,000 schemes in the PPF – in other words, there are over 1,000 schemes where the sponsor was not able to deliver the promises it made - attentions are increasingly being turned to de-risking plans to increase the probability that members’ benefits can be delivered in full. Adding additional liabilities to the already challenging burden is counter-intuitive in this context.
  • Businesses have gone through a lot during the last 12 months. That’s not to mention the three years of Brexit uncertainty that preceded COVID-19. And that test is not over. This has proven that change and flexibility has been, and is likely to continue to be, essential to succeed as a viable business. Videoconferencing has become the norm, in both our personal and professional lives. Indeed, we have found that it is a critical tool in ensuring that benefit change consultations can continue to be meaningful in any environment – indeed, it’s not uncommon to now see a member and their spouse both attending one-to-one consultations.

What next?

During 2020 many companies grasped the nettle. For them, closure was the only show in town, the latest in a series of important steps taken toward managing pensions risk and an essential part of their long-term strategy.

Looking to 2021, there still are a significant number of private sector UK DB schemes that remain open to accrual, each for only a handful of members. For many of these schemes we believe it is now a matter of “when”, and not “if”, to make a change.

Having been involved in seven plan change exercises myself in the last 12 months (as a business, that figure is closer to 50 in the UK), these have been many of the most engaged and two-way exercises I have ever been involved with - despite all the obstacles and challenges we have faced. For many companies, we suggest the time is now right to review past decisions – even if just to check that they still make sense.

Come the next iteration of the PPF’s Purple Book 2021, I’d be pretty confident in saying that this will be the year when the number of active members still earning benefits in private sector UK DB schemes will fall below 1 million for the first time – a figure that is approximately 70% lower than the 3.6 million members that were participating in private sector UK DB schemes when I joined the actuarial profession back in 2006.

The above doesn’t mean that the challenges of closing a DB scheme go away. However, building on our experiences of 2020, you can gain some comfort that now, more than ever, (and after everything we have all been through) anything is achievable.

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Steve Deverell-Smith
Director

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