Once upon a time the concept of a Defined Benefit pension scheme was seen as a reliable security. At their inception the concept of rewarding employees with a pension that was based on final salary and length of tenure was admirable, and in many cases deliverable if the backer was a blue-chip business with decades of profitable trading stretching out into the future. But by the 70’s the scale of the potential liability started to strike home and companies scrambled to manage catastrophic positions. It’s estimated that at the peak use of these schemes some 12 Million members were covered by these types of pension. As time passed it became apparent, that in many cases the size of the pension fund, and worse still the size of the liability, was far greater than the value of the company underwriting it. Each year some new horror story emerges that leaves the individual reliant on a DB pension scheme distraught and the company itself vulnerable to collapse.

Let’s be clear though: A Pension is one of the safest financial instruments there is – as a general rule of thumb. And most people would assume that a final salary pension is safer than the average pension and an optimum means of preparing for retirement. In many cases they would be right; but unfortunately in DB schemes there have been, and continue to be, unmitigated disasters. It’s not just the high profile cases like Tata Steel or BHS that cause such grief. Here in the NE of Scotland many sizeable oil sector businesses face the same problem of escalating liabilities. Most of these companies have closed such schemes in recent years and the forced restructuring of benefits has caused great distress to many. But for many companies the scale of the liability continues to threaten the scheme and the business itself. Where the scheme was started by a company that has no longer exists the problem can be exacerbated and requires careful scrutiny.

But let’s look at the well publicised disasters to understand what can go wrong. Ask the pension holders at Tata Steel or BHS: in both cases one would imagine that the pension holders felt they were supported by a reliable scheme. How could it go wrong? Well the risk with most company schemes comes down to their ongoing financial fitness and the ethical and legal control around the management of the scheme. An underestimation of the growing liability aligned with poor industry performance of the sponsor spells a recipe for disaster.

In Tata’s case the scale of the deficit is staggering. Of course it is one of the UK’s largest schemes with some 130,000 members. But only around 13,000 members are still contributing. The main problem is that Tata UK has experienced serious trading difficulties in recent years and suffered losses of some £2Billion over the five-year period to 2016. The liabilities under the pension scheme are so significant they could bring the company down. No further funding is available from its parent company. The Trustee estimates that there is a shortfall of some £2Billion within the scheme itself which could require top-up contributions of around £200Million per annum for the next 15 years: money which Tata doesn’t have. Like so many financial disasters the pain ends up being spread around. The solution being looked at is to hive-off the pension fund into a stand alone scheme that would be unable to meet the benefit levels expected but could function as a scheme. In financial investment terms the focus on one industry (the steel industry) to act as the driving force was always a risk. There is a school of thought that prefers a broader base of support for pension funds in order to mitigate risk.

What about BHS? The foundations of the problem are the same – escalating liabilities and a business facing declining profits leads to shortfall. However, in this case the alleged avoidance of liability by disposing of the business for a £1 fee stirred a hornets’ nest. The fact that the key figure at the centre of the scheme had benefited over the years by extracting hundreds of millions from the business he owned added fuel to the fire. After much public outcry a solution of sorts was found by having Sir Phillip Green top up the fund by almost £400Million: the restructured plan will provide some cover.

What is the morale of the story? It’s difficult to say because the issues are complex and the effect is massively painful for those in the firing line. One key concept is that each of us should take responsibility for our financial future. Certainly, in our view a broad risk strategy provides the best platform for security. One of the great advantages available to the individual now is that they do have options. And there has never been a better time for extracting maximum value from transferring out of DB schemes. Of course the analysis of relative value/risk has to be made. But for many the option is a lifesaver.