In January both share prices and government bond prices fell. This meant that most pension funds in the UK lost money, some of them very large sums.
In the through the looking glass world of pension calculations, the deficits of the UK funds actually fell a little. The combined deficits of all the funds coming under the Pension Protection Fund reduced from £194.5 billion to £`190 billion. This is because as government stock prices fall, interest rates rise. This is taken as good news for pension funds, meaning they might to be able to buy more income in the future for any given amount of cash.
It still seems to me losing more money by holding bonds that go down is bad news for them. If they had held more cash they would be in a stronger position today, able to buy bonds or most other investments at cheaper prices. I fully agree with those who work out the sums that losing lots of money in equities was unqualified bad news for the funds. In 2008 overall they lost 14% from holding equities, and in January 2009 another 3.7%. February so far has brought no relief from the plunge.
Why does all this matter? You could say these sums are all notional, that one day markets will rise again, that most companies will meet their obligations to present and future pensioners over the long haul. If you took such a relaxed view, you would be missing the serious crisis now facing many companies with final salary pensions.
The UK government set in train three different policies which have combined to undermine final salary pensions.
The first was the Pensions tax on investment income, costed inaccurately at around £ 5billion a year(the government refused to let us have the true figures). This removal of substantial income from the funds both hit their earnings on the investments, and helped drive down the capital values of the shares so taxed. If shares yield a large class of investors less income, it usually means they are worth less as a result. The funds also had less investment income to reinvest, so cumulatively it became a big hit.
The second was the decision to set up a Pension Protection Fund with powers to levy an additional tax on successful pension funds, to pay for the funds that got into financial difficulties. The danger today is that more companies will go bankrupt, placing their pension funds in the hands of the Protection Fund. This could strain the resources of the Fund further, requiring ever bigger levies on the funds that are still being supported by their sponsor companies. Sponsor companies strapped for cash to run their businesses will not only have to tip more money into their own fund, but will have to find extra to pay for other people’s funds that have got into an even worse mess.
The third is the regulatory system developed by the government. The Regulator for understandable reasons demands repairing the damage done by falls in values of investments within a limited time period. It means that companies have to start filling in pensions black holes whilst they are still struggling to generate cash in their own businesses. There becomes an unintended additional pressure on the company itself, where the demands for larger contributions to support the pension fund could be one of the straws that breaks the camel’s back in companies running out of cash.
Keeping the company going is probably the best way to underwrite the pension fund. Taking too much off the company to buttress the pension fund may make short term sense for the fund, but may make the longer term position worse, placing yet another fund into the hands of the stretched Pension protection fund.
What should we conclude? We can conclude that there is no substitute for pension funds making or preserving their investment money, and no substitute for each pension fund being backed by a strong company. The present combination of regulation, taxation and poor economic circumstances will spell the death knell of quite a few pension schemes, as well as the companies that went with them.
It will confirm the corporate sector’s view that final salary schemes cannot be afforded and are too risky. They are going to be a phenomenon primarily of the public sector where people still think money grows on trees. In the meantime, if the government wishes to save some pension funds and ward off more corporate collapses, it needs to do some constructive thinking about the system of creeping death it has invented for so many pension funds. If it hadn’t bought so many bank shares it could afford to do more to help. The problem is the government itself is showing itself to be a worse investor than Pension trustees, capable of losing more money more quickly.