Defined benefit (DB) pension schemes offer employees a specified retirement income. This is typically based on their salary and length of service. They’re often found in the public sector.
These schemes offer a level of financial security but come with challenges. It’s important to understand the recurring issues to safeguard pension benefits and the scheme’s long-term stability.
- Longevity risk
With people living longer, pension funds are facing a growing challenge. In simple terms, longevity risk means that pension funds may have to pay out for a longer period than planned.
This can place unexpected pressure on the fund, especially if projections are based on outdated assumptions. In the UK, average life expectancy for men is now 78.6, compared to 73.1 just three decades ago.
To manage longevity risk, it’s crucial to use current demographic data models to accurately predict how long people are likely to live. Pension schemes may need to reconsider the retirement age or adjust benefit accrual rates.
- Investment risk
Defined benefit schemes rely on investment returns to cover future liabilities.
Market fluctuations can impact the scheme’s ability to meet its obligations. If investments underperform, the fund could face shortfalls and a deficit. One way to tackle investment risk is by diversifying the scheme’s portfolio.
A balanced approach spanning different asset classes can reduce the impact of market volatility. As the pension scheme matures, shifting to lower-risk investments can manage the potential for shortfalls.
- Funding risk
Funding risk increases when the pension scheme’s assets are insufficient to cover its liabilities. This creates a funding deficit. This situation can be financially burdensome for the scheme sponsor, who might have to make extra contributions.
To address a funding deficit, sponsors must commit to an increased schedule of contributions. This might involve paying down the deficit over time.
Another approach could be offering transfer values to members who wish to leave the scheme. This can help reduce company liabilities and ease pressure.
- Regulations and compliance
With regulations in constant flux, there is a heightened risk of non-compliance, which can result in fines or other penalties. Adapting to changes can add significant administration costs to the scheme.
To overcome regulatory and compliance risks, collaborate with experienced administrators or third-party providers. Consulting with specialists who are well-versed in the complexities of a DB pension scheme is key to keeping an appropriate and compliant schedule.
Regular audits and reviews are crucial. Members must be told if there are any changes to the scheme that may affect their benefits.
By implementing strategies to mitigate risks, pension scheme sponsors can safeguard members’ benefits for long-term stability.