Brief summary of crisis facing UK employers running final salary schemes
Brief summary of crisis facing UK employers running final salary schemes
by Dr. Ros Altmann
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Our final salary
occupational pension system used to be the envy of other countries,
but is now in dreadful trouble. Almost all schemes are in deficit
and employers are finding that their pension promises have become
hugely more expensive than they ever expected. Basically, our
schemes do not have enough money to pay out the promised pensions
and contributions will have to increase sharply, to be able to
afford the payments. Why is there not enough money? There are many
reasons:
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Successive
Governments have piled extra obligations onto final salary schemes,
which have added enormously to the cost. Compulsory revaluation of
leavers’ benefits, spouse cover and indexation have all made
providing these pensions more expensive than originally thought.
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Pension funds
relied on equity investments, which delivered exceptionally strong
returns in the 1980’s and 1990’s and actuarial valuation methods
failed to predict future interest rates, inflation, investment
returns and mortality correctly. This meant that the actuarial
valuations underestimated the liabilities and over-estimated the
expected assets, to suggest that schemes had more than enough money
to pay out all the pension promises.
-
This allowed
employers to take contribution holidays, since it looked as if their
funds had surpluses.
-
Employers also
used their pension funds as a cheap way of funding industrial
restructuring, by providing early retirement pensions in voluntary
redundancy, which were financed by the pension scheme, rather than
company funds.
-
These early
retirement packages led others to want to retire earlier, so
although workers were increasingly living longer, they were also
trying to retire earlier, both elements adding to the costs of
providing these pensions.
-
Government also
imposed extra costs on schemes due to regulatory expenses and
removal of ACT relief on dividends.
-
UK final salary
pensions are now about three times more expensive to provide than US
final salary pensions. This is due to the extra requirements of
spouse cover, indexation and revaluation. The employers are unable
to reduce pensions, so they are stuck with these liabilities. This
will, in my view, be an enormous problem for corporate UK in the
coming years. Somehow or other, companies and their workforce are
going to have to find a way to change the benefits or increase
contributions substantially.
-
There may be
several major companies which will be forced into bankruptcy by the
costs of trying to meet their pension liabilities. How long will
shareholders stand for this? Essentially, these schemes are no
longer really ‘funded’, but have become more like ‘pay as you go’
schemes, where the contributions today are funding benefits for the
older members, but who will be there to fund the pensions when the
younger workers want to retire? I have actually suggested they are
now ‘pray-as-you-go’!
-
Maybe the
Government did not really get to grips with this issue because the
public sector schemes are all final salary and no-one wanted to rock
the boat and highlight the enormous costs of public sector pensions.
-
Or perhaps the
Government simply failed to realise how bad the situation was until
it was too late. The official line always was that these pensions
were ‘safe’ and ‘guaranteed’ and, like everyone else, perhaps
Government believed that these funds were strong and could provide
generous pensions for ever. There was not really any ‘scenario’
testing, or ‘what-if’ analysis, to try to predict what might happen
if schemes found they could not pay out the promised pensions that
people were relying on.The bottom line is that final salary pension schemes are a hugely
expensive, open-ended commitment by employers to pay a promised
level of pension to former workers, for as long as they live.
Employers do not know how much this will cost, but have signed a
blank cheque to keep on paying, often with yearly increases, for the
indefinite future. Governments continually tried to put more costs
onto the schemes, because state pensions were being cut and the
ideology was that private pension funds, invested in equities, could
make up for the low state payouts. In the end, it has become clear
that this is unaffordable.