Why Final Salary Pensions are in Crisis. A Solution?
by Dr. Ros Altmann
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The outlook for final salary schemes is grim. Quite simply, many companies cannot afford to honour the pension promises they have made. Why are we in this crisis and what can be done?
Trying to blame employers, actuaries, Goode or Government is pointless. The truth is, everyone involved in providing pensions is partly responsible. Those who are least implicated in causing the problems are, unfortunately, those who will suffer most. Scheme members have contributed responsibly for many years, and believed that their pensions were protected by having the assets held in trust and by legislation introduced after the Maxwell scandal. Sadly, this is not the case, but even now, the Government, pensions industry, trustees and unions are not warning their members of the possible risks that they may get no pension. Pension providers, employers, Government and unions must work together to sort out the problems, rather than looking to blame each other.
Why can we no longer rely on our pension funds to pay out the promised pensions?
The short answer to this is that we have not allowed surpluses to build up, and now that there are more and more pensions to be paid and investment returns have plunged, there is not enough money to support the liabilities. No one was willing to just let surpluses build up while the schemes were relatively young and investment returns were strong. Deficits on both MFR and FRS17 bases have now ballooned and the money is simply not there. Many mistakes were made:
- The Inland Revenue actively discouraged surpluses by taxing them
- Legislation from successive governments added layers of extra costs, which were not part of the original deal (regulatory compliance, MFR, index-linking, removal of ACT relief)
- Employers used pension funds to pay generous early retirement benefits, to hide the costs of industrial restructuring
- Employers took contribution holidays, sanctioned by actuaries and trustees
- Members asked for earlier retirement and benefit enhancements
- Actuaries used over-optimistic investment and mortality assumptions
- Trustees agreed to a mismatching of liabilities, even as pensioner numbers grew
- Asset allocation placed too great a reliance on equity returns
- Equities suffered a savage bear market
The result is that there are no big surpluses, our schemes are now three times as expensive as those in the US and companies cannot afford the future liabilities, without jeopardizing their profits and competitiveness.
One way forward lies in scheme by scheme renegotiation of the terms of the pensions promise. Just as with bank lending, if repayments become too onerous, companies try to negotiate a rescheduling. Lenders then need to decide whether to accept lower repayments or risk putting the company out of business. Pension scheme members are facing similar choices. The employers must sit down with their workforce and assess realistically what their business can afford, without risking the future solvency of the company or undermining the success of the business. This will differ from company to company. It will be very painful for the workforce, but they will have very little room to resist, if their employer could fail. A mature approach to renegotiating the terms of the pension – which is likely to encompass accepting moves to defined contribution, career average, cash balance, reduced accrual and perhaps increased member contributions – is urgently required. This will not be easy and company directors should be expected to sacrifice more of their rights than the workforce in order to reach a deal. Unfortunately, our present system protects the employer far more than the members and employers retain the right to use the ‘nuclear option’ of scheme wind-up. Under this scenario, companies can legally walk away from their obligations, at a fraction of the true cost.
It is, therefore, imperative that pension rights are properly protected, or members are clearly warned that they may receive no pension. Otherwise, any increase in contributions they are asked for may simply be used to secure other people’s pensions if the scheme winds up and they could consider suing for mis-selling.