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We all know the price of sugar and chocolate has soared, so it’s no surprise when we find that a Mars Bar costs more than we remember. The real "unwelcome discovery”, however, is when we realize the bar is also significantly smaller. Yes, it tells us the weight in the small print on the wrapper but most of us don’t read this.
This is an example of "Shrinkflation", a phenomenon that many DB pensioners will become all too aware of as they receive their first pension pay slips over the next few years.
Many members will remember that following the 2008 financial crisis, they were asked to pay higher contributions. What many forgot, or didn't fully grasp at the time, was a concurrent change in accrual rates that took place. Like the weight of that chocolate bar, it is an important detail that can be easily overlooked or not understood, until the point of consumption.
This situation will be facing many DB pensioners. For example, in the next few years those finishing a near 40-year career will see roughly half of their pension calculated using these reduced accrual rates. So, for a switch from 60ths to 80ths the unwelcome effect revealed when the member opens their pensions statement will be that, compared to when they joined the pension scheme, their pension will be around one eighth lower than they expected – and that is for the rest of their life. (For some who were moved to 120ths accrual the loss is even more severe at one quarter).
From Deficit to Surplus
Here is the twist: unlike the cost of chocolate, the cost of providing these pensions has actually dropped since those "disastrous" post-crisis recalculations. And the lower pensions now due to be paid are a significant factor in those reduced liability costs.
The actions taken: sponsors deficit contributions, increased member contributions and the accrual changes—combined with economic hiccups along the way—mean that many schemes are now showing large surpluses and are starting to consider to whom that surplus belongs. This question arises both if they intend to run on or to transfer the pension to an insurer or superfund.
The Adequacy Gap
Some of the surplus will need to be earmarked to cover continuing risk (the low dependency threshold), or the higher cost of a risk-free exit to the insurance market, and this use clearly meets the best interests of both sponsor and members. But, where there is more to be shared, it is important that the discussions consider all of the ways this surplus has arisen, and not just cash contributions.
This reduction in accrual for members also impacts on the wider discussions about pensions adequacy. It is easy to see adequacy as just an issue affecting DC members, where contribution levels from both member and sponsor have often been lower reflecting the AE minimum levels. But those with DB pensions who originally thought they were on track for a moderate retirement ((£31,700 for a single person in the June 25 update to retirement living standards) could find themselves around £4,000 per year adrift from this. Crucially those expected just to reach minimum standard will be £1700 a year short of their target for life.
The Bottom Line
For trustees and sponsors, these upcoming decisions on
surplus sharing are critical. This is not just about managing a company balance sheet. This is the "Mars Bar moment" for thousands of retirees. How surplus is distributed will define the living standards of DB pensioners for decades to come. We must get this right, or even more of our friends and colleagues will be facing straitened times in their retirement. And, of course, buying fewer Mars Bars(although, in the interest of balance, other chocolate snacks are also available!).
- Published in Pensions Expert
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