Final salary schemes face early retirement

Last month’s decision by Costain to abandon its final salary pension scheme has raised the question of whether there is a perfect storm brewing in company pensions in the construction industry, writes Michael Glackin.

Widening pension scheme deficits, continuing economic uncertainty, longer lifespans, and impending government changes to pension provision are combining to hit the beleaguered industry hard.

Figures from the Pension Regulator and Pension Protection Fund reveal that the total liabilities of the UK’s 8,000 final salary pension schemes was running at £956bn (see graph), up 15.2% over the year to July 2009. Since 2008, the last time assets exceeded liabilities, the deficit has risen to more than £150bn (see graph). The construction industry accounts for almost £30bn of that figure, a rise of £4.3bn since July 2008.

Most of the top construction companies closed their final salary schemes to new entrants some years ago, but this dramatic increase in liabilities is causing them to limit the benefits to existing members. Lee Jagger, head of corporate pensions at financial consultant KPMG, says: “They are protecting what members have already earned but ensuring they can’t earn any more.”

Weeks before Costain’s announcement, Balfour Beatty informed its scheme members that any salary increases from January 2011 would not boost their retirement benefits. Like Costain, it blamed the rising cost of financing its pension fund.

Costain’s reported pension deficit rose from £39.6m at the end of last year to £75.7m in the first half of this. To try to reduce the shortfall, Costain agreed to raise its monthly contributions over the next 15 months from £500,000 to £900,000.

“We all want certainty,” says Tony Bickerstaff, Costain’s financial director. “But we’re fortunate in that we have no debt and we’ve increased our profit, which means we can increase our dividend and our pension contribution.”

Closing final salary schemes will reduce the risk facing companies, but upcoming changes to pension legislation could force firms to reduce pensions even more.

From 2012, under the government’s so-called “auto-enrolment” legislation, workers will have to start paying into a defined pension plan or they will automatically be enrolled in their company plan.

“Auto-enrolment will lead to higher company costs,” says Jagger. “More people will join company schemes and companies faced with managing the additional costs will look at ways to reduce it. Higher membership may lead to lower pensions.”

Tony Bickerstaff, Costain finance director, agrees but believes most companies are prepared for the costs. “We have a high percentage of staff already enrolled in our scheme, so the cost is largely factored in.”

Another long-term solution to the pension problem was recently undertaken by defence group Babcock International, which transferred part of its pension risk to investment bank Credit Suisse. In the first deal of its kind, Babcock effectively outsourced the pension scheme for 4,000 staff at its Devonport dockyard in Plymouth.

But will offloading the risk offer a solution to the industry’s pension woes? Kevin Cammack, construction analyst at Kaupthing, is sceptical: “Those kind of deals have been mooted for a while, but few have actually done them,” he says. “The best way forward is still to close final salary schemes to new members and limiting the benefits to existing members.”