Falling markets, crumbling pensions
by Dr. Ros Altmann
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For some time it has been clear that the UK was facing a pensions crisis. Unfortunately, recent market turmoil has worsened the problems, as the value of most people’s pension schemes has dropped sharply. Not only does this have implications for individuals, it also has potentially worrying consequences for the public purse.
All private pension funds have suffered. Essentially, pension investors relied too heavily on stock market investments and paid insufficient attention to the investment risks involved. Corporate schemes and personal pensions are now in trouble.
Final salary pension schemes have almost all plunged into deficit in recent months. Bank of England rate cuts and abnormally low gilt yields have pushed up the value of pension liabilities, while market falls – not only in equities but also in corporate bonds, property and other investments – have sharply reduced asset values. Employers with final salary schemes have to make up for these losses and fund their deficits. However, employers are not in a position to make significant extra contributions during a recession. This is a problem for many UK firms. But it may be a problem for the Government too, which might ultimately have to provide a taxpayer underpin to the Pension Protection Fund.
Money purchase pensions (including personal pensions and stakeholder schemes), have also tended to rely on equity investments and corporate bonds to deliver strong long-term returns, so their value has fallen too. Even worse, the sharp cuts in interest rates have made annuities more expensive to buy.
The resultant falls in pension income could be substantial. For example, if pension assets have declined by 20% and annuity rates have worsened by 10%, those retiring now may receive 30% less pension than they were expecting.
This is a particular problem for the UK because our state pension is so low – just about the lowest of any developed country. Governments have always relied on good private pensions to allow pensioners to live decently. For those without private savings, there are means-tested additions to the national insurance pension – particularly pension credit. Currently, nearly half of all pensioners are entitled to means-tested benefits but, of course, the lower the value of private pensions, the more pensioners will have to claim additional benefits. Therefore, there will be extra costs to the public purse and more poverty among pensioners.
As the population ages, this will become a significant problem. The baby boom generation is just reaching pension age and suddenly there will be huge additional numbers of pensioners each year. Since the 1940s, the rate of growth of the pensioner population has been remarkably stable, but that is all about to change, as the baby boomers start to draw pensions. In a ‘pay-as-you-go’ system this means younger generations’ taxes will fund those pensions, but this poses a financing problem because there are far fewer people in the younger cohorts, due to lower birth rates since the 1960s.
This has very worrying implications for economic growth. More and more older people, not working, without much income and the younger generations struggling to pay out pensions, while spending in the economy as a whole declines.
So what can policy do to alleviate these problems? Firstly, reforming state pensions to pay all over 75s at least a decent minimum would remove some of the disincentives to long-term savings and also would end poverty among the elderly. However, especially after the latest market falls, it seems clear that pensions alone cannot solve this crisis. The uncertainties of long-term investing make it difficult to plan reliably for retirement income. Part of the solution lies in rethinking retirement. There is a whole new phase of life – for people in their 60s, 70s and beyond – waiting to be grasped. These are what I call the ‘bonus years’, when people are still working, but part-time. Gradually withdrawing from the labour force but still contributing to their own and society’s economic welfare. These ‘bonus years’ are the tangible benefit from the advances in health status, work practices and life expectancy achieved in recent decades. Private pensions then need to last less long or could just be a supplement, rather than complete replacement, for full-time earnings.
At the moment, however, policy hinders extending working lives. Pension credit penalises earnings over £5 a week and age discrimination legislation does not protect workers beyond age 65. What a waste of resources.
Since the credit crunch has destroyed many people’s pension prospects, and as we face a rapidly ageing demographic profile, policy urgently needs to address the radical reforms needed in both pensions and retirement, to allow longer term growth prospects to recover.