Lessons from the demise of BHS – how solvent are our pension schemes?
The Secret Accountant looks behind the headlines to gauge the current state of high profile schemes and how the government seeks to protect scheme members.
The failure of BHS has hardly been out of the headlines. Various reasons have been put forward to account for the insolvency of the high street giant from a failure to keep up with the times through to asset stripping by the owners. But whatever caused its collapse the fact still remains that the big losers are the estimated 11,000 workers who lost their jobs and just as worryingly, along with former employees, will face dramatically reduced retirement provisions due to the £571m pensions’ deficit that the company accrued.
But is the deficit a ‘one off’? Unfortunately, no! Many people suggest that the BHS scheme’s woes are just the tip of the iceberg and that means a lot of pensioners and workers alike may be affected in the years to come. In 2008, the BHS scheme was fully funded with a reported surplus of £3.4m. So what went wrong?
Commentators disagree on this point but the real answer is a range of things appear to be to blame, both avoidable and unavoidable. For instance, the company reportedly had a recovery plan for the scheme which extended to 27 years. They were also known for establishing ‘gold standard’ final salary pension schemes. Add to this low interest rates over the last few years producing poor gilt yields and some poor investment decisions and in the space of a few short years the scheme went from healthy surplus to huge deficit.
How does the government protect workers and pensioners caught by the deficit trap? The government has established the Pension Protection Fund (PPF). The fund was set up to pay compensation to members of eligible defined benefit pension schemes, when there is a qualifying insolvency event in relation to the employer and where there are insufficient assets in the pension scheme to cover Pension Protection Fund levels of compensation.
So the government/taxpayers, via funding from levies and other sources, picks up the tab. It pays out a certain level of compensation to affected people. For instance, the current levels for retired workers are generally 90% compensation based on what the pension was worth at the time. The annual compensation is capped at a certain level. The cap at age 65 is, from 1 April 2016,£37,420.42 (this equates to £33,678.38 when the 90% level is applied) per year. The earlier the worker retired, the lower the annual cap is set, to compensate for the longer time they will be receiving payments.
The BHS pension scheme is being absorbed into the PPF with an estimated 20,000 members facing cuts to their retirement income. The Regulator confirmed recently that it was investigating the BHS scheme and was debating whether to chase former business owners to settle pension debts, using so-called anti-avoidance powers.
How many others schemes are affected? The PPF publishes monthly reports on its website which show the latest estimated funding position, on a section 179 (s179) basis (a scheme’s s179 liabilities represent, broadly speaking, the premium that would have to be paid to an insurance company to take on the payment of PPF levels of compensation). These are effectively defined benefit schemes potentially eligible for entry to the Pension Protection Fund (PPF). A quick review of the situation for July 2016 reveals:
there were 5,020 schemes in deficit and 925 schemes in surplus
an aggregate deficit of these schemes estimated to have increased over the month to £408bn at the end of July 2016, from a deficit of £383.6bn at the end of June 2016
the funding ratio worsened from 78% to 77.4%
total assets were £1,401bn and total liabilities were £1,808.9bn.
Statistics on actual members transferred to the PPF are given only to March 2016:
PPF members transferred - 225,534
Members receiving compensation - 120,043
Average annual compensation - £4,225 per year
Total compensation paid - £2.3bn
Conclusion The collapse of BHS highlighted a potential pension scheme time bomb. The current low rates of interest will hinder recovery from a deficit and the fact that the company is a high street name clearly does not provide a safeguard.
The government is due to introduce legislation which will effectively increase the compensation payable to members by the PPF but this could be seen as a spiralling cost for the future and does not in itself provide an answer to the core issues. The PPF’s own strategic plan summarises the situation nicely:
‘We recognise that managing the future of defined benefit provision is a complex challenge, with very few easy answers, requiring cooperation and expertise across the industry.’
The Secret Accountant is a practitioner based in the heart of England who comments on issues which affect many accountants.