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Employers overpay into defined benefit pensions to the tune of £5 billion per year

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Companies are overpaying into defined benefit pension schemes, with funding targets more than 10% higher than necessary, according to research by PwC.

The report from the accountancy firm shows across corporate UK, the level of overpayments could total at least £5 billion a year.

Outmoded ways of calculating the contributions needed to cover future pension payouts do not reflect the way pension scheme assets are invested and the longer-term gains expected.

Pension scheme funding targets typically assume funds held for retired scheme members will be funded by lower risk investments such as bonds. With the proportion of pensioners increasing, funding requirements are in turn being based on a greater proportion of low growth assets, which, for many schemes, does not reflect the actual investments the scheme holds.

Jeremy May, partner in the pensions practice at PwC, said: "Current approaches to setting funding targets are too blunt, typically assuming schemes immediately switch investments into lower risk assets as members retire. The reality for most schemes is a more gradual transition of investments, particularly now life expectancies have increased. Funding requirements are therefore being based on overly conservative expectations of investment growth, and the effect is becoming more pronounced as the population ages.

"The disconnect between how pension scheme assets are invested in practice and how the funding target is set could, at worst, impact on corporate activity and adversely affect investor perceptions of a business's health. At the very least, the current approach to setting funding targets is distorting corporate decisions around how to manage better risk within these schemes."

PwC argues that funding targets should instead be based on the scheme's long-term investment strategy. This should incorporate scheme-specific changes to asset allocation but not the blanket approach currently used.