British companies’ private defined-benefit pension plans have faced deficits for years, but the post-Brexit decline in bond yields has put them under acute strain, worrying investors. The Financial Times reports:
Britain’s defined benefit pension schemes make employers offering them liable for paying guaranteed retirement income to members. The UK’s vote to leave the EU in June sparked a sharp fall in bond yields, which propelled pension deficits to all-time highs and means companies need more money to meet their retirement commitments. […]
Companies could try to pass on liabilities to insurers but this has become increasingly costly. The most likely option, therefore, is the unpalatable choice between cutting dividends or reducing investment, or doing both.
As we’ve argued at length before, defined-benefit pension plans, where retirees are entitled to a fixed payment from their old employer every year, are an artifact of the blue social model. They functioned best at midcentury, when most workers would stay with a single employer for their entire careers, and when companies were stable and secure, and less exposed to global competition and technological change. Today, such plans discourage labor flexibility, and are in any case only as solid as the company that guarantees them. Most U.S. companies (but not the government) have already transitioned to defined-contribution plans like 401(k)s, where workers set aside a portion of their income as they work, often supplemented by employer matching.
In Europe, where the blue social model is in many ways more entrenched than it is in America, employer-guaranteed defined-benefit pension plans remain widespread. Though the UK situation is unique because of Brexit, corporate pension deficits are a concern on the Continent as well. This highlights another reason why employer-supported defined-contribution plans are a far better model for the twentieth century: Putting employers on the hook for workers’ retirement can force them to cut back on investment when bond yields dip, creating an unnecessary supply-side drag on economic growth.