Running dry: pension funds hit by US cost-cutting plans

American companies have cut back on both defined benefit and defined
contribution pension schemes as a way of cost-cutting through the downturn,
thanks in part to action in Washington.

Analyst John Mauldin, famous for his free Thoughts From The Frontline
weekly e-newsletter on the US economy, reports a conversation with Standard
& Poor’s analyst Howard Silverblatt: he says that US companies’ DB schemes
are now under-funded by some $250bn, many having taken advantage of a generous
move by former President George Bush to waive the requirement to maintain
funding at 92% of scheme liabilities, lowering it to 80%.

If US companies are putting the brakes on DB schemes now that there is a less
onerous funding requirement, it stands to reason that they are also going to
hammer their payments to DC plans to which don’t have any legal minimum level of
contribution.

There has been speculation that UK subsidiaries of American companies could
now come under pressure to follow their parent company’s lead and cut back on
their contributions to their British employees’ DC plans as well. There is also
more than a little concern that other UK employers might also decide to take a
leaf out of the US’s book.

Peter Routledge, head of employee benefits at Towers Perrin, says it is now
becoming common practice for American companies to suspend corporate payments to
the company DC scheme until better times. “The idea, or the promise, is that as
and when things get better, the employer will do a ‘catch-up’ payment, or a
series of payments,” he says.

Whether the catch-up will be sufficient to offset the earnings lost is
unclear, nor is it clear how many companies will be in good enough shape when
the upturn finally comes to restore skipped contributions. Employees who have
faith in their employer actually making good on the missing payments, could be
taking too much on trust. But then, with DC schemes, there is no obligation to
make restoration payments ­ apart from any promise the employer might have
written into employment contracts ­ for the employer to pay anything at all.

Will British companies follow the American example? Routledge thinks it is
more likely that UK companies will opt for more sophisticated options, such as
salary sacrifice schemes in which the employee, with the employer’s agreement,
gives up a certain percentage of salary that the employer then adds to the
employer’s contribution to the DC pension plan.

That way, the employer saves the National Insurance it would have had to pay
on the ‘sacrificed’ slice of the employee’s salary, while the employee gets the
full tax-free slice paid into a pension. This lowers the overall cost of running
the scheme for the employer, while the employee gets a larger contribution to
their DC pensions pot.

“Quite a lot of UK companies have gone down the salary sacrifice route
already. However, we are now seeing a lot of interest from companies which
previously have not bothered with this approach. The pick up in interest for
this type of arrangement is a really noticeable phenomenon,” he says.

Better communication
Julian Webb, head of UK defined contribution at Fidelity International, agrees
there is now plenty of evidence that US companies are cutting back on DC scheme
contributions, but says there is no evidence that UK companies are following
suit yet.

However, employers are listening to suggestions as to how to cut back on the
costs associated with running DB and DC schemes ­ and getting more bang for
their buck through better communication with employees.

“What we are telling clients is, don’t just focus your attention on the
contribution rate you are paying,” says Webb. “Look at your total overall cost
of running the DC pension plan.”

In the good times, some of the larger schemes went out of their way to
provide choice to DC members. They selected separate fund managers, separate
scheme administrators for the various funds and separate communications
companies to deliver messages from the various funds to their members. All of
this reinvents the wheel several times over and adds greatly to the cost burden,
Webb says.

“The whole idea of selecting the ‘best of breed’ in each of a variety of fund
options may have been affordable in the good times, but companies are now waking
up to the fact that they are having to pay profit margins to several
organisations instead of just to one,” he says.

The ‘bundled option’, where one provider offers a total administration and
management package for a number of funds, has improved tremendously in recent
years, he argues, and is undeniably cheaper.
The other thing employers need to think about doing, Webb says, is ensuring they
are getting best value from the money they are spending on contributing to DC
schemes.

There is no point funding any benefit, be it gym membership, life assurance
or a DC scheme, if employees care very little about them. But if employers
ensure their employee communications regime is up to speed and getting all the
good messages across, then employee satisfaction surveys should start
generating much more positive feedback, showing that members really do value
their pension, once they realise its significance to their fate and future.

Default setting
Another really strong plus point for a proper communications policy, he says, is
that it will tend to focus member attention much more on whether they can do
better than simply leave their money in the fund’s default options, instead of
taking a more active interest.

“Our urgent message to plan sponsors and trustees is to review their scheme
defaults regularly,” he says. In a massive downturn, having the default as a
passive equity tracker will simply lose value all the way to the bottom of the
market. “Some kind of diversified approach that will smooth out volatility is
far and away the best option,” says Webb.

Christopher Clayton, head of the pensions advisory group at Close Brothers,
says the message his firm is hammering out to corporates today is to stop
thinking about the pension, be it DC or DB, in isolation. It is one benefit in
an array of benefits and companies need to look at their total benefit spend and
to assess where they are getting value and where they are not.

John Finch, investment consultancy director at HSBC Actuaries and
Consultants, agrees.

But he says he is disappointed that the Pensions Regulator and the
accounting standards bodies have not found a way of being a little less rigid
about pressurising employers to mark-to-market for their pension schemes in such
difficult times.

If employers were under less pressure ­ and not just cash pressure ­ then, he
suggests, they would not be trying to walk away from all kinds of pensions
problems quite as much as they are.