UK Pensions in Crisis
by Dr. Ros Altmann
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Pensions are in trouble, yet there is an air of complacency in recent Government publications which is deeply disturbing. Until recently, we were generally considered the best pensioned country in Europe – primarily due to good final salary schemes. Suddenly, it seems these pension ‘promises’ may be unaffordable, particularly for private companies. Even in the public sector, council taxes will soon have to rise sharply to pay for local authority pensions, and spending on other public sector pensions will soar.
Government says this isn’t a crisis. Well, I disagree. Quite simply, our final salary schemes have become too expensive and they’re not safe. Schemes are closing or winding-up and thousands of workers are finding that, after saving all their working lives in schemes which promised ‘guaranteed’ pensions, they could actually get almost nothing. The move to money purchase pensions is not being properly handled and stakeholder pensions have flopped. Add to this Government policies which increase means-testing, plus scandals, mis-selling and high charges, and people are becoming frightened of putting money into pensions altogether. Confidence has collapsed.
Governments have not looked after pension rights. Unlike other countries, we have no mutual insurance to help members of insolvent schemes. Thousands of pages of pensions law, a Regulator, an Ombudsman, all were supposed to protect pensions – but they haven’t. Government must act now. It should divide scheme assets more fairly on insolvency, speed-up wind-ups, ensure solvent employers fund schemes better, require mutual insurance and compensate those who were never warned that their pensions weren’t safe.
Why are we in this mess?
Problems have been building for years, but over-optimistic actuarial and investment assumptions and high equity returns misled us into believing our pensions were affordable. Employers were even allowed to take contribution holidays. Instead of letting surpluses build up when schemes were young, to provide pensions for increasing numbers of retired members over time and cushion against falling asset values, everyone tried to get their hands on these surpluses. The Inland Revenue even decided to tax them, to discourage ‘over-funding’! Companies and Governments have ‘raided’ the funds, equities have fallen sharply and the surpluses have been replaced by deficits.
Over the last 20 years, employers used pension funds as a cheap source of industrial restructuring, hiding the costs of labour force reductions in generous early retirement packages. This led to a wider trend to earlier retirement and, as people are also living longer, pensions must be paid for longer, raising costs sharply.
Successive Governments have piled extra costs onto pension funds over the years. It’s not just Gordon Brown’s 1997 removal of tax relief – the Tories imposed huge burdens on schemes too. Complex regulations, MFR, index-linking, benefit enhancements have all proved enormously expensive. Many of these changes were designed to protect members, but have actually made our schemes increasingly unaffordable. These extra costs mean average UK final salary schemes are now three times more expensive than in the US.
Why isn’t Government more concerned?
Ministers think our pension system is affordable because UK public spending on pensions is forecast to remain stable, at around 5% of GDP up to 2050, despite rising numbers of older people. The rest of Europe forecasts sharp increases to about 12% of GDP. This is partly explained by the fact that our State pension is much lower than anywhere else – but that is not a reason for complacency. Even if European State pensions prove too generous, our situation is still worrying. Instead of Government funding decent pensions for the elderly, we have shifted the costs onto companies or individuals. They will need to pay much more for pensions in future. This has worrying implications for long term growth. Relying on final salary schemes to fund the costs of supporting older people, when other countries are paying from taxation, means UK firms are not competing on level terms. Past pension promises will be a drain on future profits and will reduce UK competitiveness and long-term growth.
We must tackle these pension problems urgently and manage the move away from final salary schemes properly. Money purchase pensions can work well, but we should ensure contributions are high enough and costs are as low as possible. This requires new thinking. For example, perhaps pensions should be managed in large pools, not individually, in order to benefit from economies of scale and people must get advice, they can’t manage financial planning on their own. When will policymakers wake up to reality?