Brief summary of crisis facing UK employers running final salary schemes – 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

    Brief summary of crisis facing UK employers running final salary schemes

    Brief summary of crisis facing UK employers running final salary schemes

    Brief summary of crisis facing UK employers running final salary schemes

    by Dr. Ros Altmann

    (All material on this page is subject to copyright and must not be reproduced without the author’s permission.)

    Our final salary
    occupational pension system used to be the envy of other countries,
    but is now in dreadful trouble. Almost all schemes are in deficit
    and employers are finding that their pension promises have become
    hugely more expensive than they ever expected. Basically, our
    schemes do not have enough money to pay out the promised pensions
    and contributions will have to increase sharply, to be able to
    afford the payments. Why is there not enough money? There are many

    1. Successive
      Governments have piled extra obligations onto final salary schemes,
      which have added enormously to the cost. Compulsory revaluation of
      leavers’ benefits, spouse cover and indexation have all made
      providing these pensions more expensive than originally thought.

    2. Pension funds
      relied on equity investments, which delivered exceptionally strong
      returns in the 1980’s and 1990’s and actuarial valuation methods
      failed to predict future interest rates, inflation, investment
      returns and mortality correctly. This meant that the actuarial
      valuations underestimated the liabilities and over-estimated the
      expected assets, to suggest that schemes had more than enough money
      to pay out all the pension promises.

    3. This allowed
      employers to take contribution holidays, since it looked as if their
      funds had surpluses.

    4. Employers also
      used their pension funds as a cheap way of funding industrial
      restructuring, by providing early retirement pensions in voluntary
      redundancy, which were financed by the pension scheme, rather than
      company funds.

    5. These early
      retirement packages led others to want to retire earlier, so
      although workers were increasingly living longer, they were also
      trying to retire earlier, both elements adding to the costs of
      providing these pensions.

    6. Government also
      imposed extra costs on schemes due to regulatory expenses and
      removal of ACT relief on dividends.

    7. UK final salary
      pensions are now about three times more expensive to provide than US
      final salary pensions. This is due to the extra requirements of
      spouse cover, indexation and revaluation. The employers are unable
      to reduce pensions, so they are stuck with these liabilities. This
      will, in my view, be an enormous problem for corporate UK in the
      coming years. Somehow or other, companies and their workforce are
      going to have to find a way to change the benefits or increase
      contributions substantially.

    8. There may be
      several major companies which will be forced into bankruptcy by the
      costs of trying to meet their pension liabilities. How long will
      shareholders stand for this? Essentially, these schemes are no
      longer really ‘funded’, but have become more like ‘pay as you go’
      schemes, where the contributions today are funding benefits for the
      older members, but who will be there to fund the pensions when the
      younger workers want to retire? I have actually suggested they are
      now ‘pray-as-you-go’!

    9. Maybe the
      Government did not really get to grips with this issue because the
      public sector schemes are all final salary and no-one wanted to rock
      the boat and highlight the enormous costs of public sector pensions.

    10. Or perhaps the
      Government simply failed to realise how bad the situation was until
      it was too late. The official line always was that these pensions
      were ‘safe’ and ‘guaranteed’ and, like everyone else, perhaps
      Government believed that these funds were strong and could provide
      generous pensions for ever. There was not really any ‘scenario’
      testing, or ‘what-if’ analysis, to try to predict what might happen
      if schemes found they could not pay out the promised pensions that
      people were relying on.

      The bottom line is that final salary pension schemes are a hugely
      expensive, open-ended commitment by employers to pay a promised
      level of pension to former workers, for as long as they live.
      Employers do not know how much this will cost, but have signed a
      blank cheque to keep on paying, often with yearly increases, for the
      indefinite future. Governments continually tried to put more costs
      onto the schemes, because state pensions were being cut and the
      ideology was that private pension funds, invested in equities, could
      make up for the low state payouts. In the end, it has become clear
      that this is unaffordable.

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