Higher pension deficit payments are reducing workers’ pay by £200 a year

Squeeze extends to low earners who are outside their companies’ DB pension schemes

Today’s employees are footing part of the bill for plugging historic gaps in defined benefit (DB) pension schemes, even when they have no claim on the pension pot, according to a first of its kind study published today (Monday) by the Resolution Foundation.

The Pay Deficit, undertaken by Dr Brian Bell of Kings College London in conjunction with the Resolution Foundation, links individual- and firm-level data to shed new light on the debate around who is paying for the large increases in the costs of DB schemes that have arisen since the early-2000s.

Improvements in longevity, poor investment returns and falling interest rates have acted to significantly increase the valuation of DB deficits since the turn of the century. The report finds that UK firms allocated roughly £24bn to ‘special’ deficit-funding pension payments last year – £19bn more than would have been the case had pre-2000 levels of deficits continued to prevail.

The report shows for the first time that these increased deficit payments have led to lower pay levels for workers in the firms affected of around £2bn. It notes that wider effects of increased deficit payments may also include a combination of wider wage spill over effects that include non-pension deficit firms, reductions in profits, or lower investment. This £2bn drag on pay is worth £200 a year on average to workers in firms with DB pension deficits.

The Resolution Foundation says that the presence of such sizeable DB deficit payments has important implications across generations, with older workers and those already in retirement standing to gain most from the plugging of gaps. Of the 10.9 million members of DB schemes in the UK, 40 per cent are retired and fewer than 2 per cent are aged under-30 and still contributing. Half of the nearly 6,000 DB schemes in operation are closed to new members and a further third (35 per cent) are closed to future accrual.

The Pay Deficit finds that every increase in deficit payments equivalent to 10 per cent of a firm’s total wage bill feeds through into an average reduction in hourly pay for its employees of roughly 1 per cent.

This effect is most pronounced among employees who remain active members of the pension scheme, but is statistically significant among deferred members too – that is, those employees who have previously saved into the pension but no longer contribute.

More worryingly, this drag on pay also extends to the lowest paid workers who have never been members of their firm’s pension scheme. The report finds that for those sitting in the bottom quarter of the pay distribution and never having benefitted from the DB pension scheme, the reduction in hourly pay associated with a given increase in deficit payments is roughly twice as large as the average effect for all employees. In contrast, the effect on similar workers in the top quartile of earners is not significant.

The Resolution Foundation says that the lowest – and often youngest – earners in deficit-paying firms are therefore suffering pay penalties even though are not the beneficiaries of action to close these pension deficits.

With average earnings still languishing at £16 a week below their pre-crisis peak and a fresh pay squeeze now hitting as inflation rises, the think tank argues both that the growing ‘wedge’ between overall remuneration and employee pay packets warrants greater scrutiny, and that discussions of DB deficits need to broaden from the current focus on whether the schemes concerned are sustainable to include a full assessment of the distributional impact of such deficits on pay, dividends and investment.

Matt Whittaker, Chief Economist at the Resolution Foundation, said:

“Pay growth has under-performed in the UK for well over a decade. While the financial crisis fall-out and recent combination of rising inflation and productivity stagnation have had the biggest effects, wages actually started to flat-line before the crash hit. Understanding what contributed to the pre-crisis slowdown in pay growth is crucial to determining what might come next.

“Our research shows for the first time that there is indeed a link between rising pension deficit payments since the turn of the century and reduced pay. The scale of increased deficit payments reduced workers’ wages by around £2bn last year, with workers in affected firms losing out on £200 on average.

“This drag on pay has important implications across generations as low – and often younger – earners in affected firms are losing out on pay even when they are not entitled to the pension pots they are plugging.

“With average earnings still £16 a week below their pre-crisis peak and prospects for a return to strong pay growth looking shaky, it’s important that younger and low paid workers don’t take a hit to their pay because of deficit payments to pension schemes that they’re not even entitled to.”