There is little relief for European corporates with under-funded defined benefit (DB) schemes as quantitative easing, subdued inflation, and low economic growth depress long-term bond yields.
A report by S&P Global Ratings – ‘Little relief in sight for corporate pension pain’ – says the “perfect DB storm remains”. It adds that market developments continue to conspire against the majority of European corporates with DB schemes.
The firm also highlighted the difference between some of the major European states’ DB schemes. For instance in Germany there are DB schemes where beneficiaries receive payments directly from the company on a pay-as-you-go basis. Companies are under no commitment to make external payments or provide assets to support their pension promises.
Contrast this to the UK and the Netherlands; when funding ratios fall below certain levels, a recovery plan is agreed. In the UK this typically results in higher company contributions and scheme members’ benefits are generally protected.
S&P puts forward three main ways to tackle the European wide DB funding gap problem. To reinforce DB solvency, companies could provide additional voluntary contributions to increase scheme assets to address funding shortfalls.
Firms could also change asset allocation, whereby underperforming schemes may target higher investment returns, although this would require taking on more risk. As pension funds tend to have quite conservative mandates, S&P does not view this as particularly viable.
Finally, S&P suggested reducing benefits. In the UK faced with the prospect of pensioners experiencing lower payouts if insolvent DB schemes fall into the Public Protection Fund, some bodies- including the Pensions and Lifetime Savings Association according to S&P- are proposing that benefits such as indexation and provision of spouse’s benefits should no longer be a legal requirement.
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