Financial Adviser feature on future of UK occupational pensions – Ros Altmann

    Ros is a leading authority on both private and state pensions,annuities and
    retirement policy. Numerous major awards have recognised her work to
    demystify finance and make pensions work better for people.

  • Ros Altmann

    Ros Altmann

    Financial Adviser feature on future of UK occupational pensions

    Financial Adviser feature on future of UK occupational pensions

    Adviser feature on future of UK occupational pensions

    by Dr. Ros Altmann

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    Employers have
    always been considered a vital part of UK pension provision.
    However, companies are rapidly pulling out of their traditional
    final salary pensions role. Workplace pensions are likely to be
    defined contribution in future. The movement away from final salary
    schemes is a huge challenge for pensions policy and could deliver
    exciting new opportunities for financial services companies and IFAs.

    The UK model of occupational pensions has developed over past
    decades and, until recently, we prided ourselves on having one of
    the best occupational pension systems in the world, with employers
    promising lifelong support for their workforce and taking on all the
    risks involved in pension provision.

    In fact, successive UK Governments kept cutting state pensions with
    the expectation that private pensions, invested heavily in equities,
    would offset these reductions and also generate adequate provision
    for pensioners. The exceptionally high equity returns in the 1980’s
    and 1990’s encouraged the belief that equities could be relied on to
    always perform well. However, since 2000, falling stock markets,
    along with falling inflation, lower interest rates and rising life
    expectancy, have left employers struggling with huge deficits in
    funds they had not-long-ago thought were in healthy surplus. More
    realistic accounting rules and increasingly mature schemes, which
    have to pay out generous pensions to more and more pensioners, are
    forcing employers to totally reassess their commitment to pensions.
    This represents a crisis in future pension provision. Suggesting
    sensible, sustainable solutions, requires unravelling some muddled

    Essentially, pensions have two distinct roles, firstly, providing
    social welfare and secondly as an investment vehicle.

    The original idea of pensions was to provide some social insurance
    for people who were too old to work, so they could survive. This
    role would normally be considered a State responsibility, but UK
    employers have been fulfilling this role too. The end of final
    salary schemes represents employers pulling out of social welfare.

    Over time, pensions have also become an investment vehicle, although
    this was not the original idea. Pensions help people save while
    working, in order to have something to live on when they are no
    longer able to work. Defined contribution employer schemes and
    personal pensions are designed to help with this aspect of pensions.

    The problem with UK pensions policy at the moment is that neither of
    these two roles is being properly fulfilled. The social welfare role
    of pensions has been hit by continuous cuts in state pensions and
    employers retreating from final salary schemes. The investment side
    of pensions has suffered from disappointing investment returns,
    falling annuity rates and successive scandals, which have undermined
    confidence in long-term saving.

    In order to improve pensioners’ social welfare, Government decided
    to introduce the pension credit, as a means-tested top-up to state
    pensions. The majority of pensioners will be entitled to it but this
    does not end pensioner poverty because a fifth of pensioners do not
    claim their benefits. More worryingly, though, the means-test
    penalises private pensions by at least 40% – and for many people by
    100% – so it is no longer safe to save in a pension. Pensions are no
    longer a suitable investment for many people and financial advisers
    cannot safely advise basic rate taxpayers to put money into a
    pension. Thus, in trying to provide social insurance via pension
    credit, government policy is undermining occupational and private
    pensions savings vehicles.

    Pension policy is caught in a vicious circle. If we keep going as we
    are, the UK is heading for economic decline and huge swathes of the
    population in poverty.

    It seems that employers are being squeezed out of pension provision,
    which is very worrying. It is not just the cost of providing final
    salary pensions (which is well over 20% of salary now) but it is
    also the uncertainty of the cost, which makes final salary pensions
    so difficult for employers. Finance Directors have taken over
    responsibility for pensions from human resource departments, leading
    to a radical review of employer pension provision. In future,
    employers can only really be expected to help with the investment
    aspects of pensions, in the form of defined contributions and we
    should recognise that they need incentives to do this. Workplace
    pension schemes are often now viewed as a company ‘cost’ rather than
    a company ‘benefit’ and companies are far less certain that they can
    justify providing pensions.

    With lifelong employment a rarity and average job tenure only around
    five years, employers can no longer be expected to provide social
    welfare. The State has to pick up this role. What policy needs to
    do, however, is to encourage employers to help with the investment
    aspects of pensions instead, in an effective manner through improved
    defined contribution pension arrangements.

    With more flexible employee benefit packages, the spread of
    means-testing in the state pension system and increasing levels of
    debt in the population, evidence suggests that most younger people
    are no longer interested in pensions. In this environment, many
    employers do not want to offer pensions at all and the longer this
    situation persists, the lower pension coverage will be. Both
    employers and individuals need new and better incentives to provide
    pensions, but radical change of our whole system is needed before
    such measures can be expected to succeed.

    Part of the solution to the pensions crisis seems to me to lie in
    having a clear distinction between the two functions of pensions,
    with Government taking on the social welfare responsibility and then
    encouraging the private sector to provide additional savings on top
    of this, free from means-tested penalties. Organising such savings
    via the workplace seems to be a sensible route.

    So what changes do we need? Introducing a £110 a week citizen’s
    pension, indexed to earnings, would deal with social welfare,
    without undermining the investment role of pensions. The basic state
    pension and state second pension would be merged and everyone would
    be entitled to this basic minimum. This would then leave the private
    sector free to offer savings and investment products to all, with a
    clear message that financial advisers could give to clients.
    Government provides enough to live on, but only just. Anyone wanting
    a better lifestyle later will need more. If your employer can help,
    so much the better.

    Abandoning S2P and the complexities of contracting out could save
    £11billion a year of contracting out rebates, easily financing the
    £7 billion a year cost of a citizen’s pension. This would end state
    earnings-related pension provision, but is this a problem? Firstly,
    S2P will become flat-rate in future anyway, and secondly, why should
    society ensure that higher-earners also receive higher pensions?
    Surely it is up to individuals how much they save and a
    well-functioning financial services sector should be able to provide
    attractive pension products.

    Once the State takes care of basic social welfare, it would not
    longer be essential to force people to contribute to pensions or to
    require them to annuitise their savings. There would be freedom of
    choice, but it is in the social interest to encourage people to save
    if they can.

    Since it can no longer be automatically assumed that employers have
    a duty to provide pensions, they are likely to need meaningful
    incentives to offer pensions to their workforce. Workplace provision
    is much more cost-effective than individual pension arrangements, so
    employer schemes are important and employers would have an important
    role in facilitating pension saving. Individuals, too, need better
    incentives. Just relying on tax relief – which gives least help to
    those who need most – is unfair and inefficient. Matching incentive
    payments, say an extra £2 for every £3 everyone contributed, would
    be fairer and more effective. Extra rewards for employers who ensure
    generous pension contributions for their staff could also be

    So, in future, employers can provide access to pensions and perhaps
    be encouraged to contribute on behalf of their employees, because
    the workplace is a useful way of pooling resources and harnessing
    economies of scale. Financial advisers can help employers to do

    To sum up then, solving the pensions crisis requires urgent radical
    changes. The Government should provide a universal Citizen’s Pension
    to take care of social welfare, sweeping away the complexities of
    S2P, contracting out and pension credit. In addition, the State must
    provide fairer and more powerful incentives to encourage employers
    and individuals to fulfil the savings element of pension provision.
    Financial advisers and financial services companies have a key role
    to play. Their challenge is to help companies and individuals
    understand what can be done to achieve successful investment returns
    for the future in a defined contribution pension arrangement.
    Organising the investment side via the workplace is the best way to
    achieve economies of scale and advisers should be preparing to help
    employers and individuals manage the change from defined benefit to
    defined contribution pensions.

    By assuming these high returns would last into the future, employers
    thought they could provide generous final salary pensions at very
    low cost! Indeed, employer pension schemes – many of which were
    established in the 1970’s – did so well in the bull markets, that
    actuaries suggested these schemes were in surplus and that employers
    could reduce their contributions and enhance members’ benefits. In
    the industrial restructuring of the 1980’s and 1990’s, it proved
    very convenient to fund redundancy costs via a pension scheme in
    surplus, by offering generous early retirement packages. In fact,
    the Inland Revenue was tempted by these surpluses too and to tax
    surpluses above a 105% statutory level. Policymakers took the
    opportunity to pile extra burdens onto employers’ schemes, requiring
    them to provide spouse cover, inflation-linking and revaluation of
    leavers’ pensions.

    When employers started providing pensions, lifelong employment was
    much more the norm. Loyal workers served their employer straight
    from school and stayed with the company until they were too old to
    work. Employers felt a paternalistic duty to look after these
    employees once they had left the firm. It gradually became the mark
    of a ‘caring’ employer to provide a ‘decent’ pension for their
    workers. Worker representatives pushed for better coverage, more
    generous provision and human resources departments insisted that
    they needed to offer good pensions in order to attract the best
    employees. The final salary pension was seen as the ‘gold standard’
    of company benefits, in which the employer promised to pay a
    pension, based on the member’s final salary, for as long as the
    worker lived after retirement. While schemes were young, no-one
    worried much about the long-term costs of this. However, most final
    salary schemes now have to pay out huge amounts in pensions each
    year, so they do not have the luxury of waiting and hoping that
    equity returns will be high enough in the long term to meet their
    liabilities. Employers are struggling with huge deficits, as the
    costs of continuing to offer final salary pensions are far higher
    than they ever dreamed of when they started these voluntary schemes.

    Policymakers would still need to encourage the investment element of
    pensions, to give as many people as possible more than the state
    minimum, but compelling employers or individuals to save is not the
    answer. Many employers and individuals are in debt and forcing them
    to contribute, would damage economic welfare. In any case, extra
    pension contributions would have to come from somewhere, and would
    reduce wages, investment, employment or profits. However, ‘soft
    compulsion’, including contributing part of each year’s pay rise
    into a pension, or automatic enrolment into company schemes, while
    still allowing people to opt-out, would still allow for individual

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