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Defined Benefit

Corporations continue to freeze plans

On both sides of the Atlantic, companies see no room for traditional pension funds

Lynda Whitney said Brexit concerns are making U.K. DB plans particularly vulnerable.

As low interest rates and growing deficits continue to blight corporate defined benefit funds, sources expect to see more plan sponsors globally freeze or otherwise alter their retirement offerings.

Last month airline operator British Airways became the latest in a string of corporations to announce a potential freeze of its DB plan, the 15.5 billion ($21 billion) New Airways Pension Scheme, London, in an effort to plug a 3.7 billion deficit.

Other private-sector moves this year include:

U.K. workers at BMW voted in July to accept a revised offer to freeze two U.K. pension plans. U.K. DB assets were a combined €8.7 billion ($10.4 billion) and deficits totaled €1.6 billion, as of Dec. 31.

Also in July, global engineering business GKN PLC froze two U.K. DB funds following discussions with affected employees and unions. The total net asset value for the funds was 2.5 billion, with a combined accounting deficit of 1.06 billion. Participants were transferred to the firm's defined contribution plan.

United Parcel Service Inc., Atlanta, said in June it will freeze two DB plans in 2023. The $18.6 billion UPS Retirement Plan had a funded status of 73.5% as of Dec. 31. UPS does not report the assets or funded status of the second plan, the UPS Excess Coordinating Benefit Plan, because it is a non-qualified excess plan that represents less than 1% of UPS' pension assets, a company spokesman said.

Corporations seem to be struggling with their DB obligations. Recent data from MSCI Inc. on global corporate funding of retirement obligations show the gap between required payouts and the resources set aside to fund them was largely unchanged in 2016 from the year before, but significantly worse than in 2007.

In its latest Global Pension Study, MSCI said the median funding level for the largest U.S. companies in 2016 was about 82% of projected benefit obligations vs. 100% in 2007. North American and Western European corporations showed the highest average ratio of underfunding in 2016, said MSCI.

"Corporations have been closing their DB plans to further accruals, and generally have been trying to reduce their pension exposure by having more investments be liability driven, thus reducing the exposure to swings in yields," said Agnes Grunfeld, New York-based vice president at MSCI and author of the survey report. "However, this also lowers exposure to investments that might enable pension assets to grow more robustly. Another strategy is to transfer the risk to insurance companies by buying annuities for covered retired employees. Unfortunately, the companies that are in trouble can't easily afford the premiums."

Ms. Grunfeld added that trustees "will have to consider allowing or even encouraging companies to take more investment risk — for example, reversing the trend away from equity and other growth investments."

Hard times in the U.K.

The U.K. in particular is hurting right now, with the uncertainty over negotiations that will pave the way for the country to leave the European Union.

The latest figures from the London-based Pension Protection Fund's 7800 index of DB funds show an aggregate 220.4 billion deficit for the corporate funds as of Aug. 31, a 22.4% jump from July 31. The funded level fell to 87.6% from 89.4% a month earlier.

"U.K. schemes are generally looking at their overall risk in this more uncertain world," said Lynda Whitney, London-based partner at consultant Aon Hewitt. "Where it is efficient they are looking at reducing risk, whether through hedging interest rates, hedging some currency risk or through taking advantage of the excellent current buy-in pricing. Trustees are having to keep a watching brief on their employer's covenant (or funding obligation) especially if the company is vulnerable to some Brexit scenarios. This is an area where taking (The Pensions Regulator's) advice and looking at contingency plans is important." These contingency plans should set out actions taken under certain circumstances that would limit the impact of risks that materialize, according to the regulator.

Charles Cowling, Manchester, England-based director at JLT Employee Benefits, said freezing and closures are not "unexpected. Because wherever you are in terms of your existing scheme and ability to manage deficits and so on, one of the key things that has hit is the reduction in interest rates, which massively increased" the cost of providing retirement benefits.

The strain on all corporations is evident in the numbers. "We are seeing some contribution rates double over the period of three years." Other employers are incurring costs "well north of 40% of payroll," Mr. Cowling added. When the plans were set up, costs were typically in the single-digit region, and "rarely more than 10% to 12%," he said.

Analysis by JLT showed the total cost of pension liabilities at FTSE 100 firms grew 16.2% to 681 billion as of Dec. 31, despite plan freezes and contribution increases of more than 4 billion in 2016. As of Dec. 31, 10 FTSE 100 companies had total disclosed pension liabilities greater than their equity market value.

"When you are paying such a large amount for pension benefits … it is inevitable that companies will have a long, hard look at it — irrespective of the deficit issues," said Mr. Cowling, who added that every employer in the private sector is likely considering the future of its pension fund.

Losing out, everywhere

Mr. Cowling said that while there are "slightly different issues across Europe … the lower interest rate environment is the same everywhere. Pretty much everywhere, DB is losing out" to defined contribution.

Data from the financial regulator De Nederlandsche Bank show the number of retirement plans in the Netherlands has fallen 62.4% to 192 over the decade ended June 30, largely due to consolidation. The decline is largely related to corporate plans, said the regulator.

Martijn Vos, managing director, pension and insurance risk management at Ortec Finance in Rotterdam, Netherlands, said plans were either closed or moved to an industrywide arrangement or a "general pension fund" — collective plans that may cover defined benefit, defined contribution, multiemployers and cross-border plans.

Mr. Vos said reasons for the decline "are the increasing governance burden and increasing cost," acknowledging that since Dutch pension liabilities are based on market interest rates, the European Central Bank "policy of the last years (has) had a negative impact on funding ratios." Contributions have also increased. Mr. Vos said looking forward, one of the main challenges for Dutch plans is to "earn enough return to avoid further reduction of pension rights."

Regarding differences between Dutch and U.K.-based plans, Mr. Vos added: "Compared to their Dutch counterparts, pension fund trustees in the U.K. are deprived of an important risk-mitigation instrument," conditional indexation. Under conditional indexation increases in payments depend on the plan and the sponsor having the resources to meet these obligations. If the plan is running a deficit and the sponsor is unable to plug it, no increases would be paid. Trustees also must be satisfied that the best interests of participants would be served in the case of suspending indexation under this arrangement.

Other countries are even further down the line.

Jan Willers, partner and COO at consultant Kirstein A/S in Copenhagen, Denmark, said there are "very few corporate pension funds left" in that country. "Most have either merged into European pension funds, and most other schemes are now with the big life insurance companies."

He said the pension funds were "too small to be efficient in terms of investing," and there was a "focus on cost. Getting access to a well-diversified portfolio is a challenge for many of those corporate pension funds."