Many Housing Associations still offer their employees access to defined benefit (DB) pension arrangements either through the Social Housing Pension Scheme (SHPS) or the Local Government Pension Scheme (LGPS). This is contrary as to what is happening in the UK’s private sector workplace where DB pension schemes are being closed by employers and employees are offered generally inferior defined contribution (DC) pension arrangements.
Why are DB pension schemes on the decline?
DB pension schemes are the “gold standard” for private pension provision in the UK, but worryingly most DB schemes in the UK have a deficit.
DB schemes pay a pension to members based on their service and salary whilst in the scheme. Contributions are paid by members and the scheme’s sponsoring employer which are invested into one common fund that is used to pay members’ pensions when they reach retirement. If the value of the scheme’s investments is lower than the current value of the benefits promised to members, then the scheme has a deficit. There are a few reasons why DB schemes have a deficit.
• While it’s great news we have higher life expectancies than 30-40 years ago, people living longer means their pension is paid for a longer period which increases the cost of running these DB arrangements.
• Over the years, successive governments have put in place extra guarantees for members including annual increases, which were not in place when these schemes were set up. This, again, increases the cost to the sponsoring employers.
• Yields on government bonds are at historic low levels following the banking crisis of 2007/2008. When bond yields are low this increases the cost of providing a DB pension. To put it into context, a 1% fall in bond yields can increase the cost of providing defined benefits by as much as 20%. Since the banking crisis, bond yields have fallen by around 3%, so you can see why many DB schemes are in deficit and are struggling.
SHPS latest funding valuation
At the end of 2018, the results of the most recent SHPS actuarial valuation were sent to the 500 or so employers that participate in SHPS. Based on the points mentioned earlier, the deficit increased from £1.3bn to £1.5bn and the cost of providing future defined benefits in SHPS is increasing by around 30%.
As a result, Housing Associations have some big decisions to make:
• How will they fund the additional deficit contributions?
• How will the increase in the cost of providing future benefits be split between employees and employers with the risk that big increases to employee contributions could make current arrangements unaffordable to some employees?
• Should they offer inferior DB pensions to employees that are more affordable (for both employees and employers).
• Should they stop offering DB pensions to employees and replace them with DC arrangements.
This will be compounded further for many Housing Associations when the actuarial valuation results for the LGPS are published late in 2019 and no doubt this will have a similar theme as to that for SHPS.
To date, most Housing Associations have bitten the bullet and continued to offer DB pension schemes to their employees but perhaps this is now becoming an unrealistic promise to members.
I have no doubt that Housing Association senior management teams and Boards are considering the above and many will be engaging with professional advisers like us to provide them with the expertise at the start of this unwanted and uncomfortable but necessary journey. ●
Stuart Price, Partner and Actuary