The Impact of COVID 19 on Defined Benefit Pension Schemes

As we continue to witness the hard impact that the COVID-19 is having on the global economy, in the last month It has been reported (Source) that the impact has resulted in defined benefit scheme deficits reaching around £500bn and experts warn that if this period continues, they could reach as high as £900bn. This is a very worrying time for companies funding Defined Benefit pension schemes and the members within them.

Employers make contributions to Defined Benefit Pension Schemes to cover their pension promise liabilities and these are primarily invested by the Scheme in the stock market and government bonds. The fall in stock markets have a very direct effect on the funding of these pension schemes as the underlying investments decrease. However, it is important to note that the reduction of UK interest rates ALSO has an effect due to an increase in the valuation of the underlying pension promise liability. In the last month interest rates in the UK have dropped to an ALL TIME LOW of 0.1% which has had a direct impact on defined benefit schemes.

Think of it as ‘How much does my Company have to invest in government bonds to generate the pension income level (from the interest rate) that I have been promised in retirement?’. When interest rates reduce, this means that more funds are required for the investment to generate the same level of income. In other words, when interest rates drop, the cost to your employer to fund the scheme increases.

The cost of the liability of the pension promises is directly related to the transfer value of the benefits. As the cost of the liability increases by way of the reduced interest rate, then the related transfer value also increases.

With the drop in interest rates hitting an ALL TIME LOW of 0.1%, this has resulted in potentially GOOD NEWS for members, as the transfer values being offered may be at an ALL TIME HIGH.

Many individuals may also be worried about the significantly increased pension scheme deficit levels, if their company can afford these and if their scheme is protected by the Pension Protection Fund (PPF).