Pensions Crunch

Pensions have been one of the great failures of the Blair and Brown administrations. Politicians with a five-year electoral horizon have little incentive to tackle difficult reforms, where the only hope of thanks would come 20 or 30 years hence, when today’s voters come to retirement. But when New Labour was elected in 1997, with every expectation of a long stay in power, it had a chance to make positive long-term changes. The reverse has happened, and last week’s budget has done nothing to change the largely dismal record.

I had hoped against hope that the leaks of Alistair Darling’s plans to reduce higher-rate tax relief on pension contributions were incorrect. Not because I have any great sympathy with those earning more than £150,000 a year, who will see their pensions tax benefit scaled back, but because Darling’s ill thought-out move is likely to accelerate the retirement crunch that threatens to take over when the credit crunch eventually leaves off.

Darling rightly pointed out that a quarter of all the money this country spends on pensions tax relief goes to the top 1.5% of savers. If he had really wanted to address the issue of fairness, however, he would have taken the much bolder step of restricting all tax relief on pensions to 20%, and recycling the money saved into boosting provision for those on more modest incomes.

Redistribution was not on the agenda. What he has actually done – and it bears all the hallmarks of his master, Gordon Brown – is to impose a contorted measure aimed at scoring electoral points by hitting the rich, though it will not make a jot of difference to the super-sized pension already accrued by Sir Fred Goodwin, who received an £8.3m boost to his pension fund in 2008, even as Royal Bank of Scotland was collapsing.

The unintended consequence, as we report below, is that it will sound the final death knell for the traditional company pension scheme. Even before this change, three out of four final salary schemes had closed their doors to new members and one in four of those that remain were saying they intended to pull up their drawbridges. By hurting the executives who make the decisions on whether or not to keep a fund going, the chancellor removed one of the last remaining incentives to do so: self-interest. Thanks, Darling.

The new regime will add further layers of complexity onto an already hideously complicated pensions system, and it is likely to undermine savers’ and companies’ confidence that there is a stable policy environment for long-term financial planning. Very high earners will be able to engineer some other way of saving tax efficiently; more modest ones will pick up the signal that the government’s support for pensions is patchy at best and many will conclude there is no point saving at all.

The erosion of final salary pensions cannot be blamed entirely on the government: other factors have played a significant part. These include a decade of poor stockmarket returns, longer life spans, which make it more expensive for companies to support their former employees, and the fact that managements have spent billions – some of which could have gone into pension funds – on activities aimed at boosting the share price, and the bonus pot, such as mergers and acquisitions. Pensions neglect has left huge deficits looming over corporate Britain, threatening to dampen share valuations and jeopardise recovery. We hear a lot about the profligacy of the past decade but one rarely mentioned debt is that owed by company pension schemes to their members – an obligation too many funds will struggle to meet.

But if Labour is not the only, or even the prime, cause of the pension crunch, it has done little to help and a great deal to make it worse. There have been some improvements, such as the Pension Protection Fund, a safety net for people who lose their pension when their employer goes under, yet the government had to be forced to help hundreds of thousands of people who risked losing their retirement income when their schemes were put into wind-up before the PPF came into effect. Brown’s disgraceful and heartless treatment of the Equitable Life victims continues even now, almost a decade after the collapse. After defying the verdict of the Parliamentary Ombudsman that a compensation scheme should be established, he sought to delay and minimise payments by appointing retired judge Sir John Chadwick to prepare a report on discretionary redress; I doubt Chadwick’s deadline is pressing.

Back in 1997, one of Gordon Brown’s first acts as chancellor was to launch a raid on tax credits on pension fund dividends, raising £5bn a year. It was not a move that impinged on most people’s consciousness, though they will pay the price in retirement. Mervyn King is at it too: the Bank of England’s quantitative easing (QE) programme is hitting annuity rates and causing pension fund deficits to widen. The combined deficit for companies in the FTSE 350 index has risen to £182bn from £163bn in the first quarter of this year, and QE has played a part in that.

What Brown learnt early on was that pensions were a good way of raising money without hiking headline tax rates. The government has abandoned its pledge not to increase the top rate of income tax, but is still raiding voters’ pensions, in a way that would have gladdened the heart of that old rogue Robert Maxwell. Shouldn’t we wise up?

Equal really does present opportunities

If the business lobby is believed, commerce in the UK is a very fragile flower. It is under assault not only from higher tax on top “talent” – and there’s more than a column to be written on the misuse of that word – but also by heinous attempts to make firms fess up if they are still failing to pay female staff fairly.

As if the budget weren’t bad enough, they say, compulsory gender pay audits, to embarrass firms which pay women less, are to be announced this week in the equality bill, championed by Labour deputy leader Harriet Harman.

The British Chambers of Commerce views these as a burden and a deterrent to international investors. Quite the reverse: a gender pay audit is a useful business tool, not an imposition. Any company that genuinely wanted to maximise talent would conduct a voluntary survey, to make sure it was a magnet for the most able women.

Forty years after the Equal Pay Act, female workers still suffer a 17% pay cut simply because of their gender. A new report by headhunter Heidrick & Struggles found 85% of board directors are male; the progress of senior women, it says, has been “painfully slow” and has dropped slightly in the past two years. Some of this disparity is probably down to the career choices made by women, who are more likely to opt for the “mummy track”, but the gap is too wide for it all to be explained away.

The business moan-athon on this subject is fundamentally misplaced. Greater equality – not just on gender, but on race, age and social class – will help us out of the crunch.

http://www.guardian.co.uk/business/2009/apr/26/pensions-tax-relief

Northern Ireland has poor pension systems for many private sector employees.

 

Most employees of private firms and businesses do not have the benefit of a substantial employer organised pension scheme.

Not only is there a problem of unsatisfactory post-retirement pension incomes, there are growing problems for many people who are members of a formal defined benefit pension scheme organised by their employer.

Basically, the existing defined benefit schemes are proving more and more costly.

Defined benefit (DB) schemes accumulate contributions from employers and employees into earmarked funds that are invested with the expectation that, on retirement, an employee will have a pension related to his earnings when he retired.

These schemes usually offer a pension (with a lump sum) that at least might be equivalent to about 50% of previous income.

The funding of these schemes has been stretched by a number of adverse changes. In part, funds invested have recently been hit by the fall in the capital value of investments.

In another part, these schemes offer pensions for life to people who are now living much longer than the actuaries assumed when the schemes were started.

Just to confirm the local position, a review of what is known from the largest 100 businesses in Northern Ireland points to (at least) 37 which have recently operated DB schemes.

Not all employees necessarily qualify to join a DB scheme: many are only open to senior managers or other selected groups.

Of these 37, three have decided to close the scheme to any further new members and 20 are known from recent accounts to be carrying an actuarial deficit.

Hardly surprising, therefore, that the debate between pension providers has turned to an assessment of the longer-term prospects for DB schemes and, where deficits persist, how the schemes can be restored to viability (or closed).

Kevin Wesbroom, Director, Kerr Henderson Hewitt, confirmed last week to local trustees, that the deficits in DB schemes are a global feature, not peculiar to Northern Ireland.

When eight of the 20 schemes last reported they had a deficit that was the equivalent of 10% or more of the assets of the scheme.

The financial strains are imposing a search for adjustments. More interestingly, the emphasis appears to be shifting to find means of withdrawing from DB schemes.

While this is understandable from an employer’s perspective, that still leaves the employees with questions on how to accumulate funds to finance retirement.

The Kerr Henderson Hewitt professional research has been examining ways to restore viability and other ways to reduce long-term commitments.

To restore viability some schemes have:

• Increased employee contributions

• Reduced the rate of accrued benefits

• Closed the scheme to new members

• Closed further accrual to existing members

• Switched to link to career average salary

• Capped any pension increases

• Raised the retirement age

• Introduced a salary sacrifice option.

More radically, options are on the table for decommissioning the DB scheme by:

• Selling the scheme through the Pensions Insurance Market

• Buying out members entitlements

• Offering members an annuity based buy out

• Offering members enhanced transfer values

Kevin Wesbroom takes a cautious view of DB (final salary) schemes.

He said: “We are getting close to the end game now for final salary schemes. They have simply becoming too expensive for employers to support.”

He is not hopeful that Government will be willing to take the unpopular decisions to protect pensions by, for example, raising the retirement age. The present formula is unaffordable!

Yet, if employers need to withdraw from too expensive commitments, then employees must see that this puts the onus on them to plan alternative forms of saving.

http://www.belfasttelegraph.co.uk/business/opinion/john-simpson/cost-of-defined-benefits-now-leading-to-a-pensionsrsquo-crunch-14098491.html

Despite deteriorating market conditions adding around £20 billion to the FTSE 100’s pension accounting deficits in the first half of this year, around six out of 10 FTSE 100 companies are potentially paying too much into their pension schemes, with up to half overpaying by over £20m a year, according to KPMG’s 2008 Pensions Repayment Monitor.

And the situation could get worse as nervous pension trustees, rattled by the current market turmoil, may demand more funds to shore up the growing perceived deficits.

Pensions partner, Mike Smedley, commented: “We are heading for a ‘pensions crunch’ as nervous trustees demand more cash from companies just as those companies have less of it.”

The demands stem from an understandable desire to take a more cautious view in the current uncertain economy. However, cash diverted into the pension scheme is not available to the rest of the business and KPMG’s 2008 Pensions Repayment Monitor suggests that six out of 10 FTSE100 companies are paying more into their pension schemes than is actually required to clear the deficits within a reasonable (10 years) time period.

“It’s all a question of timing,” added Mike Smedley. “At a time when cash is plentiful, using it to clear debt can be a very good idea – similar to a householder flush with cash deciding to pay off a mortgage early – but as the credit squeeze tightens, financial obligations need to be prioritised and if pensions can be met over a longer time period, that can reduce the demand for cash outgoings today. This flexibility ought to improve the long-term health of companies which is the pension trustees’ primary interest.”

Results of the 2007 Survey

The 2008 KPMG Pensions Repayment Monitor’s analysis of year end accounts shows that 70 per cent of FTSE 100 companies with defined benefit pension schemes could pay off their pension deficits (calculated at the end of 2007) in a single year using pure discretionary cash flows. This is an improvement on 2006 when 50 per cent of companies could have done so and on 2007 when the figure was 60 per cent. Over 2007, the accounting deficits of the FTSE 100 fell by around £40 billion.

And extending the time period to three years gave an even more positive figure with 80 per cent of the sample able to clear deficits in this time frame, up from 70 per cent in both the previous surveys.

In addition, the number of companies recording an accounting surplus in the 2008 sample increased to 21 compared with only 9 in the 2007 survey.

Although the proportion of those companies able to pay off deficits quickly increased, 15 per cent of the sample are unable to clear them within any realistic timeframe without diverting cash from elsewhere. For this group, pensions remain a significant challenge.

For the first time, the KPMG Pensions Repayment monitor examined the FTSE 250, where it revealed that 60 per cent of those with defined benefit pension schemes could clear their deficits from discretionary cashflow within one year and 70 per cent within three years. A limited analysis of the 2006 sample conducted for comparative purposes suggests that just 25 per cent of these companies could have cleared their deficits within one year at that time and around 50 per cent could do so over a three year period.

A trend set to continue?

The decline in the markets since the end of 2007, (the FTSE 100 index was at 6,456.90 on 31st December 2007 and at 5,477.5 on 7th August 2008) has led to an increase in pension deficits. However, close to six out of ten FTSE 100 companies are still paying more than is required to pay off their deficits over ten years.

As well as market movements, pension liabilities are highly sensitive to the assumptions made about the longevity of the current and future pensioners the scheme is providing for. The pensions regulator is putting pressure on trustees to use much stronger longevity assumptions for funding purposes which could increase total liabilities by around £40 billion.

Mike Smedley commented: “A sustained fall in the markets will inevitably lead to an increase in assessed pension deficits and increasing mortality assumptions will add further pressure. How the pension trustees react to this can have a profound effect on a company. Additional cash pumped in now may make the trustees feel better but in practice will make little difference relative to the impact of market movements and long-term company strength. Trustees are very long-term creditors and need to work with companies to develop a coherent strategy to manage pensions through these turbulent times.”

The Buyout Option

The market for “buyout” (where a company pays a third party insurer to take on the pension scheme liabilities) has grown significantly recently as a result of increased competition among buyout providers and the impact that credit conditions have had on pricing.

For trustees and companies wishing to secure pension liabilities and their inherent risk, buyout can be an attractive option. But, for many companies, a full buyout may not always offer best value or the most efficient method for managing pension risk and pension financing. A number of companies are beginning to implement actions themselves similar to those taken by those insurers offering formal buyouts to manage pension risk, rather than go to a third party to insure their liabilities in full.

Mike Smedley concluded: “Whilst a buyout of pension liabilities can be the right solution in some circumstances and many companies and pension trustees are actively considering it, buyout is not a panacea but one of many ways to tackle pension risks. In some ways buyout could even be seen as a last resort for strong companies who cannot reach an efficient funding and investment strategy with their trustees”

http://www.camagonline.co.uk/News/1025.aspx