Labour’s Legacy – destruction of pensions
by Dr. Ros Altmann
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The credit crisis has hit the economy hard and the latest economic data confirm we are now in recession. However, the crisis has also engulfed our pension system as the recent sharp falls in markets and interest rates, coupled with difficult trading conditions for most companies, have significantly worsened the prospects for company pensions.
Before 1997, our pension schemes were the envy of other countries. The gold standard final salary pension funds, which are the most generous company pensions you can have, used to be the norm in the UK. In the past, millions of people were building up pension entitlements from their employer, so that when they retired they would know what pension they would have and could plan for their retirement. These pensions are dying out and data just released suggests the trend away from final salary schemes is accelerating.
The National Association of Pension Funds – the body representing employers who run company schemes – has just published results of a survey into the effect of the credit crisis on company pensions. They make very worrying reading.
The Survey shows that employers are now likely to be closing their final salary schemes not just to new recruits, but also to existing members. We all know that private sector schemes have been closing to new members for the past few years, but it seems that even those already in the schemes may have to change to new, more risky, arrangements in future.
This has significant implications for everyone in private sector final salary schemes. [Of course, the public sector schemes are not affected at all, because they have a taxpayer guarantee to protect them, but private sector schemes are funded by employers who carry all the risks and who can no longer afford to underwrite such expensive, open-ended commitments.] Presumably we all hope to be pensioners one day, but if pension schemes are in trouble, what will we live on?
This is a particular problem for the UK because our state pension is so disgracefully inadequate. We have about the lowest state pension of any country in the developed world. Therefore, a private pension is not just the icing on the cake for people in retirement to help them afford life’s little extras, it is actually part of the cake. Without a private pension or other forms of private income, pensioners will not have enough money to live on at any decent level.
There are many reasons why these schemes have been closing. Having appeared to be in healthy surplus during most of the 1990s, they have now plunged into huge deficit. Government policy is partly to blame for these deficits. In particular, one of Gordon Brown’s first policy decisions, in 1997, was to take huge sums of money out of final salary schemes. He increased taxation on pension funds significantly. In fact, estimates suggest that over the last 12 years this decision has removed well over £100billion from final salary pensions.
This was the start of the demise of these schemes, from which they have never recovered. The latest data add further evidence to the view that we are in the final chapter for final salary schemes and that within the next few years they will all close.
Of course, this is not all the fault of Government policy. Pensions have also been hit by falling stock markets, falling interest rates and rising life expectancy, which have all dramatically increased the burdens on employers trying to run final salary schemes.
But the end of final salary pensions is a real problem for millions of workers because their retirement income will not be predictable at all. Final salary schemes enabled workers to predict roughly what they would receive in retirement. Their pension would depend on their earnings just before retirement (their ‘final salary’) and the number of years they had been in the scheme. However, with more modern pension schemes that most workers will be increasingly switched to, the amount of pension will depend on the investment performance of their funds, what charges they incur and the cost of the annuity they will buy on retirement. None of these elements can be predicted accurately, so the whole process of saving for a pension becomes more of a lottery.
That is why the death of final salary pension schemes is so worrying for us all. If pensions become far less generous and the state pension remains so low, we will have millions of older people struggling to make ends meet, which is bound to depress long-term economic growth.
These problems must be addressed. Maybe because their own pensions are so secure and are still the ‘gold standard’ final salary schemes, politicians and policymakers have not yet recognised the urgency. However, it is inevitable that the Government will have to get to grips with these problems properly. Firstly, it must underpin the Pension Protection Fund – the insurance protection for workers whose employers fail, so that it does not run out of money. Secondly, it must help employers struggling with their final salary scheme deficits – perhaps allowing them extra time to make up the shortfalls. Finally, and most urgently, the Government should issue gilts specifically aimed at pension funds, to help them meet their liabilities. Instead of focussing so much attention on the banks (who have already failed!), policymakers need to concentrate more on trying to prevent failure in other areas, such as pensions.
So far, this administration has presided over the demise of our once-envied pension system and has done nothing to revive it. Indeed, many of the policy changes since 1997 have made the situation worse. As the best company schemes are dying out, and replacement pensions will not deliver much income, it is hard to escape the conclusion that this Government could go down in history as the one which destroyed the UK pension system.