The Case for Government Compensation for Insolvent Employer Pension Victims
by Dr. Ros Altmann
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• Government legislation is, in large measure, responsible for the loss of scheme members’ pension rights. Flawed legislation, the negligence with which Governments have encouraged people into occupational schemes without risk warning and prohibition of diversification, mean members whose years of contributions have been confiscated to pay other people’s pensions have to be compensated.
• Ministers have said that deciding on compensation is difficult and asked for proposals as to how this can be done. This document provides this.
• Compensation will cost nothing for at least 5 years, during which time, Ministers can plan to set aside funds to provide for the ongoing liabilities in future.
• Urgent action is needed to restore some confidence in pensions. No members of UK final salary schemes can feel completely safe at the present time.
HOW THE GOVERNMENT CAN COMPENSATE:
• Start date:
The provisions of the 1995 Pensions Act, 1996 deficiency regulations and mandatory limited price indexation came into force in 1997. This is, therefore, the date which should be used as the start-date for compensation claims – i.e. 6th April 1997. It was after this that Government legislation prevented trustees of pension schemes from dividing up scheme assets on an equitable basis, removed any requirement to warn members of the effect of insolvency on their pension rights. Furthermore, the pensionstheft.org website has not been contacted by anyone who is in a scheme which wound up before 1997.
Instead of forcing schemes to buy index-linked annuities, allow scheme assets to be drawn down to pay pension commitments as they fall due. It is important to require the winding-up process to be halted while this is organised. The Government could establish a central fund into which the scheme assets are transferred, running parallel to the PPF perhaps. This will reduce costs of administration and ongoing investment management charges, by benefiting from economies of scale in managing the larger pool of assets. Pooling the funds will also mean the high costs of wind up (often over 5% of scheme assets) will be saved.
By using scheme assets to pay out pension liabilities on an ongoing basis, instead of buying index linked annuities, a typical scheme has sufficient funds to cover all costs for at least 7 years. Compensation will, therefore, not cost anything for many years to come and this will give time to find or set aside funds for the purpose.
The attached note shows how compensation will have zero cost short term and is likely to cost around £100million a year in the longer term, if planned for properly, although in some years, the cost will be above this. The amount of pension could be capped to reduce costs and reduce the incentive for employers to enter insolvency voluntarily before the PPF starts.
WHY THE GOVERNMENT MUST COMPENSATE:
• Successive Governments actively encouraged people to join occupational pension schemes and promoted the benefits of these, without ever mentioning the risks. Scheme booklets were allowed to use words like ‘guaranteed’ and ‘promise’ and were not required to mention the risk that pensions might not be paid.
• Since Government promoted and encouraged occupational scheme membership (even allowing employers to make joining the company scheme a condition of employment) it was reasonable for members to assume that the benefits ‘promised’ were secure.
• Official advice was that occupational schemes give a known amount of pension, in contrast to private pensions, which depend on investment performance and annuities to provide a particular level of pension. In practice, this is not true and many members would have been better off in personal pension schemes, if they had realised the risks.
• Furthermore, Inland Revenue rules prevented scheme members from having any other pension savings. This would not matter, if the pension contributions to employer schemes were secure, but they were not. Therefore, Government rules prevented diversification and forced members to put all retirement assets into a fund which depended on the continued existence of their employer. This is like investing all their retirement savings in the shares of their employer. If the employer failed, they could potentially lose all their pension – which is exactly what has happened to many.
• After the Maxwell scandal, the Government introduced measures which led people to believe that pension rights were even more strongly protected than before. In fact, the opposite was the case.
• Even worse than this, at the same time as the law was changed to put in the transitional priority order for winding up a scheme, the legislation also removed any requirement for members to be told what would happen to their pension rights if the employer failed!
• The 1995 Pensions Act (including MFR provisions) was introduced with the stated aim of protecting pensions. However, the MFR does not provide protection at all and the assumptions have been allowed to become so outdated that the funding of UK schemes is no longer adequate to provide ‘promised’ pensions.
• In practice, the law provides protection solely for those who have already retired at the expense of all other scheme members. By establishing an unfair statutory priority order, protection was removed from non-retired members, whose contributions, including funds transferred in from other schemes, are used to pay pensions to others.
• The 1995 Pensions Act was therefore badly flawed. The Government has recognised this and the proposed insurance scheme will protect non-retired scheme members on wind-up some time in the future. Anyone who has had their pension rights taken away by the flawed priority order is entitled to compensation for this loss of property.
• Several legal challenges have been started. If and when these succeed, the taxpayer will have to pay compensation anyway, and will also have to meet the legal costs. It is simpler, cheaper and fairer to agree to pay now and would reflect well on New Labour.
• Compensating people who have been wronged by the pension system now will help to restore some measure of confidence in pensions. It is, otherwise, simply not safe for anyone to be encouraged to put money into their employer’s scheme.