Ten years ago Ministers still claimed that the UK had the best system of occupational pensions in Europe. They could point to the fact that British people had more money saved in pension schemes than all the rest of Europe put together. The creation of the occupational pensions movement, and the establishment of a final salary scheme by most medium sized and larger employers meant many could look forward to a decent income in old age, and retirement at 65.
Today, the picture is very different. Large numbers of schemes are closed to new members. Many are also closed to existing members, who are no longer allowed to save more to add to their final salary scheme. We are currently hearing of very large and well financed companies deciding they too can no longer afford to go on with generous pension schemes, and are about to close theirs. Some schemes have collapsed, along with their sponsor companies.
How did we get into this mess?
Many schemes are in substantial deficit because
1. The tax on their investment income, introduced in 1997, reduced the investment return and damaged prices of shares the funds owned over the ensuing 12 years.
2. The last ten years (to March 2009) have seen no positive returns on UK and US shares. The Credit crunch and recession have wiped out all the gains of the decade, leaving pension funds considerably worse off than if they had remained in cash.
3. Those valuing funds make assumptions about how much future inflation there will be. The higher inflation is, the more money the pension fund needs to pay out the higher pension payments. Most valuers these days insist on an inflation rate higher than the 2% target rate the Bank says it will keep to – at a time when RPI inflation is negative. Government reliance on low inflation figures is not reflected in pension fund valuation.
4. The good news that people are living longer is bad news for pension funds. They are having to provide more money to pay pensions for longer.
5. Pension funds now have to pay a tax or levy to the Pension Fund Protection scheme. In other words,successful funds are now taxed to pay the losses on less prudent funds. This additional cost makes employers even keener to keep down the contributions on their own fund.
6. Regulation has greatly increased, requiring employers to spend more and more money on legal, actuarial and other advice and compliance. Trustees find it very difficult to make sensible decisions, as they are so hedged around by the rules. The main conclusion of most of the advice is that funds should now own more and more government debt, despite this only producing an income of around 3 to 4%. People fear this will not enable them to pay all the pensions in the future at an acceptable level of contributions.
The result of all these pressures is that many companies say they cannot afford the large contributions now required, and cannot afford the risk of the open ended commitment to employees. Some companies are in the position where the pension fund is worth much more than the company, and where the future pension risks and costs are higher than the main risks and costs of running the business. Western companies facing these costs have to compete with Asian companies that often carry no such requirement.Pension costs can help bring an entire company down in a competitive global market.
It is a sad example of where the combination of higher taxes and more regulation leads to the end of a good idea, instead of being its salvation. Never have pension funds been so regulated. Never have so many been closing down or cutting back. Government has contributed it make it both too dear and too dangerous for many to run a final salary pension scheme. Paradoxically, having achieved that for the private sector, the government continues with such schemes – many completely unfunded – in the public sector. This is becoming a matter of controversy, generating a big sense of unfairness. I will look at what could be done to rebuild pension savings and to establish more fairness in a later blog.