Has Happened To Our Pensions?
by Dr. Ros Altmann
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We used to have a pension system that was the envy of the rest of
the world. This system is now crumbling and companies are moving
away from final salary occupational pension provision. Not only
this, but many thousands of people, who thought they had a
‘guaranteed’ pension and had been relying on their employer’s
pension promise, have suddenly found that this pension has
The Press have been trying to blame Gordon Brown’s removal of
Advanced Corporation Tax (ACT) relief in 1997 for the problems, but
this is simply not true.
There are many, many reasons why our pension schemes are in trouble.
It is not possible to point to just one or two factors.
Responsibility is widely spread.
The Tory Government, under Nigel Lawson’s Chancellorship, made a big
mistake when it decided to tax pension fund surpluses in the late
1980’s. These surpluses should have been allowed to build up, in
order to cover schemes for times when markets turned down and/or
when more and more people retired and needed to receive pensions
from the scheme. Essentially, we have failed to let the surpluses
build up and they are just not there when we need them.
After this, successive Tory Governments piled on more and more
costs, thinking pension schemes would always be able to afford to
pay more out, because they still had big surpluses. Of course, the
reason pension funds had the surpluses was because not many people
were actually drawing pensions yet (there were far more people
contributing than numbers retired) and also because equity returns
had been unusually high and scheme assets had grown faster than
expected. But the pool of assets was too tempting for politicians to
resist. They kept wanting to pile more costs onto pension schemes,
(partly perhaps as a way of hoping to reduce the future costs to the
Exchequer of supporting an ageing population), but in the process
making pensions more and more expensive for companies to provide.
Then the Tories made the many mistakes surrounding the 1995 Pensions
Act. This Act came into effect in 1997 and forced all employers to
guarantee to pay fully index-linked pensions to all members (up to
5%). On top of the many other mandatory requirements (like spouse
cover, preservation and revaluation for deferred members etc which
had been introduced over the years) this added enormously to the
costs of providing pensions. The measures are all, in themselves,
excellent for members but, by making them compulsory, there was no
‘safety valve’ in the system. If investment returns fell, or if the
employer’s business was in trouble for a couple of years, they could
not escape these extra costs.
The 1995 Act also introduced the Minimum Funding Requirement (MFR)
and regulations requiring more costs to prepare Statements of
Investment Principles, pay for compliance and regulatory expenses
etc. These measures again were intended to benefit members and make
pensions ‘safer’, but added to the costs of running the schemes. In
addition, of course, they had the terrible effect of leading people
to believe that their scheme assets were safe if it was ‘fully
funded’ on the MFR for example. The 1995 Act also introduced the
iniquitous priority order rules, which mean people not yet retired
can end up losing all their pension! No provision was made to
protect pensions of those very close to retirement, or to protect
monies transferred in from other employers’ schemes.
Finally, of course, this Government removed ACT relief altogether –
but this had already been reduced by the Tories during the 1990’s,
so it is not entirely fair to blame all on Gordon Brown.
Overall, successive Governments have conspired to make our pensions
more and more expensive and legislation has made them less safe.
Even though funding requirements were introduced and a regulator (OPRA)
and an Ombudsman were set up to oversee the system, the law did not
actually have proper safeguards to ensure people would receive the
pension they were promised.
Then we come to the role of employers. They too could not resist
getting their hands on the tempting pool of assets sitting in the
pension funds. They used these to hide the costs of industrial
restructuring in the 1980’s and 1990’s, by giving people generous
early retirement benefits (paid for by the pension scheme). This
also led other members to expect to be able to retire early, which,
of course, means that the pensions have to be paid for longer and
longer, as life expectancy has continued to rise.
Employers took contribution holidays. This is a real problem,
because they should have kept paying in to build up assets to cover
for times like now, when markets and investments go wrong, while
more and more pensions still need to be paid. The employers relied
on actuarial assumptions that showed equity returns would deliver
strong growth consistently over time and, therefore, make the
pension promises seem affordable.
Which brings us to the role of the actuaries and trustees.
Actuaries’ forecasts allowed schemes to take contribution holidays
and trustees trusted their actuarial advisers to give them reliable
forecasts of what contribution rates should be recommended to
employers. If the actuaries said the employer could take a
contribution holiday and still afford to pay the promised pensions,
the trustees didn’t question this. They did not think to ask the
actuaries, how it could be that there were more and more people
retiring, the costs of providing pensions were rising, equity
returns had been very strong and yet think this could just be relied
on to continue into the foreseeable future. Equities should not have
been relied on to keep providing strong returns. As markets rose and
schemes became more mature, the equity component should have been
reduced, but instead it was actually increased!
In addition, people are living much longer and expecting to retire
earlier and earlier. Pensions were never meant to last for 30 or 40
years. Yet the pensions industry fooled itself into thinking that it
could provide really good pensions with not very high contributions.
Finally, of course, interest rates have fallen to very low levels
and this has meant the costs of providing pensions – especially via
annuities – has rocketed.
All these factors have come together to leave us in the mess we are
in today. You cannot just blame the Government, or the employers, or
the actuaries, or the trustees, or the investment managers. The
whole industry must share the blame and it is time to get real. The
system is not working and must be sorted out, to help provide decent
pensions for people in future.
We have been deluding ourselves perhaps, to truly think that
companies can afford these kinds of open-ended liabilities for ever
without keeping aside enough money to pay for them. Especially with
all the extra costs we have piled on over the years.
I think the latest measures announced by this Government have been
an excellent first step along the road to getting a better and safer
pension system in place in the UK. If we are moving away from
defined benefit and final salary schemes – which seems inevitable –
then we must make sure we spend time to structure alternative money
purchase arrangements properly, help people to think about gradually
retiring, rather than suddenly stopping work in their 50’s and
protecting people whose employers have promised to pay them a
particular level of pension.
Those who lost their pensions with no warning, while thinking they
were properly protected by the law, should be compensated and we
should make sure this does not happen to anyone else in future. We
are closer to this today than we were last week and that, for me, is
Summary of reasons why pension fund surpluses have disappeared and
are no longer there now that we need them:
1. Nigel Lawson decision to tax pension fund surpluses
2. Successive extra mandatory costs – preservation,
deferred pension revaluation
3. 1995 Pensions Act – MFR, priority order, limited
4. Removal of ACT relief
5. Employer contribution holidays
6. Employer use of surpluses for industrial
7. Trend to earlier retirement expectations
8. Increasing longevity
9. Actuaries investment and mortality assumptions too
10. Benefit enhancements which could not be removed
11. Maturing of schemes (i.e. more pensions needing to be paid as
12. Over-reliance on equity investment
13. Trustees not questioning actuarial advice
14. Plunging stock markets
15. Sharply lower interest rates