There can be little doubt that
pensions in the UK are in a perilous state. Philip Boucher canvasses expert
opinion on what needs to be done.
A great deal has been made of
the decline of final salary pension schemes. But while this has been galling to
some, it at least makes economic sense from an employer’s perspective. The
schemes typically account for around 15 per cent of a pensions payroll, hike up
administration costs and have uncertain contribution rates. Alternatives like
money purchase schemes cost employers half the money and create half the
headaches. And final salary schemes reward long service with one employer –
something of a rarity these days.
The problem lies with the shift
in emphasis that this signals. The TUC expressed concern that responsibility
for pensions is being transferred from the State and employers to individual
workers and far fewer people will set up adequate pensions as a result.
A study by KPMG Pensions
research backs this up. It found that the rejection of final salary schemes
could cut pensions by up to a third and leave people financially short when
they retire. Currently, they believe that 43 per cent of companies running
defined contribution pension schemes are contributing 5 per cent or less. In a
typical final salary scheme, companies average contributions of up to 10 per
Confusing alternatives also
cloud the issue. At launch, stakeholder pensions were supposed to provide a
retirement safety net for the low paid. However, it is the well-off who have
rushed to take up a stakeholder policy because it enables them to safely invest
a percentage of their money.
A study by Marks & Spencer,
which surveyed 1,598 adults aged 18 to 65, found that only half of the
population know what a stakeholder pension is. And 41 per cent have not taken
out a pension because they cannot afford to – exactly the situation that
stakeholders pensions were introduced to avoid.
The same principle can be
applied to almost any aspect of pensions. Thousands of people with private
pensions were recently urged to switch back to State Earnings Related Pension
Scheme (Serps) by Legal & General, Prudential, Standard Life and Equitable
Life – the big insurers saying that private pensions will not provide
comparable funds to the state scheme.
Prior to this, the Government
announced proposals to give fixed-term workers the same right to company
pensions as permanent staff – something the CBI and the Employers Forum on
Statute and Practice (EFSP) say is unworkable. The CBI estimates it will lead
to £13m in unnecessary administration costs and £98m in extra pensions
contributions when it is implemented in July.
bureaucracy and legal obligation (FRS17) and increased life expectancy have
also combined to increase the cost of pensions.
Firms like ICI, BT, Iceland and
Ernst & Young have looked to the demographic costs of the future and
realised that their final salary pensions schemes have to be closed to new, and
in some cases, existing members.
The result is a pensions
situation that, while not necessarily in chaos, is certainly confusing and
edging ever further from the stability of previous years.
Michelle Lewis , TUC
"The UK pension system is
in peril. For more than 20 years the State has been retreating from the
provision of an adequate retirement income for all citizens. In the past,
employers recognised they had a responsibility to help workers save for
retirement, however, this social contract is now under threat with the State’s
retreat from pension provision being matched by the employers’ headlong rush
away from good, defined benefit pensions.
"The fundamental principal
on which the TUC’s pension policy rests is that all workers must have a secure
income in retirement that enables them to maintain a standard of living similar
to that which they enjoyed in their final years of employment.
"The state pension is the
foundation stone of the system and this needs to be built on by employers and
individuals saving through decent occupational pensions schemes. Employers
should be able to make membership of occupational pensions a condition of
employment, and employers should also be compelled to contribute to an
employee’s pension. The simplification of pension legislation should also go some
way to improving the current complexity of pension provision.
"The challenge for the
future is to ensure those workers without access to occupational pensions are,
in the future, given access to a quality pension. Stakeholder pensions were
intended to achieve this objective, but without significant employer
contribution the full potential of stakeholder is unlikely to be fulfilled. The
really big issue is not the nature of provision, but the amount of employer
contribution. Low contributions to money purchase schemes are the major failing
of those schemes at the moment.
"If this trend is not
directly addressed before the balance between DB and DC shifts much further, we
will condemn future generations of retired employees to a life on means-tested
benefits rather than high-quality occupational pensions.
Paul Thornton, senior
partner at Watson Wyatt
"It has been easy to feel
rather smug about UK pensions. They have long looked in rude health compared to
many of Europe’s state-sponsored, pay-as-you-go schemes. The linchpin of UK
pensions has been the funded, defined benefit company pension scheme. But with
timing that could not be more damaging, UK company pensions have been hit by a
"Firstly, people are
living longer, therefore drawing pensions for longer. Secondly, a low
inflation, low interest rate economy is not conducive to enduring double-digit
investment returns. Also, the global economic slowdown has forced many
companies to focus on costs. Trimming, or at least holding down, the cost of
employee benefits is tempting and relatively easy to do in a soft labour
Lastly, we have a new
accounting standard, FRS17, which highlights pension fund deficits in company
accounts. Coming as it has, after the worst couple of investment years for a
decade, many schemes are in deficit, leaving employers uncertain about carrying
the financial risk of defined benefit pensions.
"The choice for employers
of how to deal with pension provision is far from black and white. The idea of
a wholesale switch to defined contribution pensions is oversold. We are likely
to see more employers setting up schemes which share the risks and rewards more
evenly between employer and employee, with average-earnings related pensions
and other innovative pension plan designs.
"The Government has a role
to play here. Employers are not required to set up pension schemes, but if they
do, they face a quagmire of legislation, requiring them to provide benefits in
specific forms and fund their schemes to a minimum level. The Government needs
to listen to the recommendations which come out of the Pickering review. It
also needs to allow greater flexibility for employers to provide the sort of
pensions which best suit their business and their employees.
Tim Keogh, European partner
at Mercer Human Resource Consulting
"What with the confusion
over contracting-out, the demise of final salary schemes, and the miss-selling
of Equitable, you could be forgiven for thinking the UK pension system is about
to collapse. Of course, it is not that bad, but there are problems.
"The 1980s and 90s were
great for pensions. Good demographics and high investment returns allowed a
significant increase in provision. People are leaving the workforce at an earlier
age, in spite of a significant increase in life expectancy.
This is not sustainable in less
benign times, and symptoms are emerging. There are many untidy patches to the
state scheme. Lower real interest rates mean a higher cost to promise a given
level of final salary pension, and companies are wary of the increased cost and
"What needs to be done?
Firstly, the Government needs to recognise the change and give clearer signals
to help plan the future. It should simplify its own offering, looking to ensure
the State provides for those who cannot, but making it clear the majority need
to save more privately.
"The Pickering review, due
in the summer, also provides an opportunity for the Government to start tidying
up the confusion of initiatives, including simplifying state pensions. And
there are signs of progress. Although stakeholder pensions are not reaching
their original low-earner targets, they have created the ‘1 per cent world’ of
‘cheap and cheerful’ private pensions for the middle earner.
"The trend towards fewer
final salary schemes is unstoppable – regulation (MFR, FRS17) may have been
ham-fisted, but it has surfaced genuine underlying risks and cost increases
which many companies find unacceptable.
"So be it – a decent money
purchase scheme where the risks are clear may be better than final salary
without adequate employer backing. And employees will be more interested –
understanding of the importance of pensions is set to grow and grow.
Jamie Bell, senior policy
adviser, employee resourcing, CBI
"It is a turbulent time
for occupational pension schemes. Many companies are closing their final salary
schemes and unions are partly blaming employers. It all seems a far cry from
the election year of 1997, when many company schemes were comfortably in
surplus and some were enjoying contribution holidays. But why are companies
taking these decisions, and why now?
"Of course, the current
economic environment is very different. Stock market growth has slowed, leading
to valuations that reduce the predicted pension pot. And the population is
ageing, which means pension schemes are funding ever-growing liabilities.
Pensions are looking like a risky venture, and final salary pensions, where all
risks are borne by employers, are looking like a cost that many businesses can
ill-afford to bear.
"But what should we be
doing? Few people would relish the idea of working into their 70s to secure a
decent pension. The Government does not want to pick up the bill – it wants to
expand the private sector pensions market from 40 per cent today to 60 per cent
by 2050. But companies can’t go to the wall to fund their pension scheme. The
Government should be encouraging the development of occupational pension
schemes, but it is clear that, since 1997, things have got worse rather than
"In 1997, the Government
took £3bn per year out of pension funds by removing dividend tax relief – a
measure that could cost employees even more than a rise in income tax.
"Now there is FRS17, which
forces companies to account for pension schemes on a snapshot basis, even
though pension funds deliver returns over the long-term – creating enormous
volatility in company accounts. For some companies which were already
considering whether they could continue to afford final salary pensions, this
measure has pushed them over the precipice.
"So from a business
perspective, what should the Government be doing to encourage pensions rather
than discouraging them? Firstly, replacing the minimum funding requirement was
welcome, but careful negotiation is needed in the EU if the gains made by its
abolition are not to be reversed by the pensions directive; FRS17 should also
be modified to allow smoothing of asset values. Most company pension schemes
are heavily invested in volatile equities and a shortfall in one year could
easily turn into a surplus the next.
"The Government also needs
to throw its weight behind the pensions simplification review. It is time to
think the unthinkable – regulators cannot protect all pension scheme members all
the time from every conceivable eventuality. Finally, the Government should
find ways to return the money taken from pension schemes by the removal of
dividend tax relief.
"If the Government wishes
to encourage the development of occupational pension provision, it must be less
prescriptive in its attitude towards pension regulation.”
Mark Childs director, global
compensation & benefits, Fidelity Investments
"UK company pension assets
exceed 90 per cent of GDP, compared to just 5 per cent in France. At the same
time, state pensions consume 3 per cent of UK GDP, compared to around 14 per
cent in Italy. Judging by these figures, if there is a pensions crisis, it is
not in the UK.
high-profile companies abandoning defined benefit (DB) pension schemes – where
pension is defined in advance based on salary and service – in favour of
defined contribution (DC) schemes – where contributions are defined but pension
depends on investment returns and the cost of annuities – is creating an
illusion that ‘DB is good, DC is bad’.
"Companies want to reduce
the financial risk of DB and are tempted to use developments such as new
accounting rules as a scapegoat for change. Experience shows that employer
contributions to DC schemes will generally be lower than the amounts paid into
DB, so not only is risk being transferred to employees, but companies are
putting less money into their pension plans.
"The demographics also add
to concerns, as people are living longer and retiring earlier. The fact most of
us are so confused by tax incentives and pensions in general combines to leave
few people saving enough for retirement.
"If HR professionals gave
more attention to the proportion of employment earnings replaced by pension, a
more balanced approach to risk and increased employee awareness of the
importance of retirement, some savings might emerge. From government, one
straightforward set of tax incentives to encourage retirement saving would also
help, as would part DC funding of UK state pensions.
"Sadly, the Government is
likely to put-off such radical action.
"Employees will probably
be slow to recognise that their pension assets might be worth more than their
home and continue to retire early. Companies look certain to continue to
implement low contribution rate DC plans and may ultimately feel obliged to
top-up company pensions with ex-gratia payments, or re-discover an element of
Steve Webb MP, Liberal
"Every week the list of
companies switching from final salary pension schemes to money purchase schemes
grows longer. Many companies are blaming their sudden change of heart on the
FRS17 accounting standard, but the truth is that fundamental problems for the
future of funded pensions have been building-up over a period of years and will
remain unless pension provision is completely overhauled.
"To put all of the blame
on FRS17 is to shoot the messenger. It is not the accounting standard, which
has created a deficit in company pension funds; primarily, it is the
combination of increasing life expectancies and a fall in returns that have put
such pressure on funds. FRS17 has highlighted these in a rather dramatic way,
but has not created a problem that did not already exist. The important issue
is not creating a scapegoat, but finding effective, long-term solutions to the
pension crisis, which will ensure all future pensioners are provided for.
"The switch from DB to DC
is made far more serious by the fact that many firms are using the opportunity
to slash their overall contributions. Therefore, the first response to this
would be to try to ensure companies put adequate sums into pension funds on
behalf of their employees.
"The introduction of a
compulsory minimum contribution for all employers would be one response to this
problem. This could ensure that ‘good’ employers who contribute significantly
into their employees’ pensions were not undercut by those who did not. This may
also need to be complemented by allowing employers to require all employees to
be members of the scheme as a condition of service.
"It is important to
remember, however, that company provision is only part of the jigsaw. For many
employees who do not have access to an occupational scheme, an employer
contribution to a stakeholder pension could provide a kickstart to the
Government’s goal of extending pension coverage among people on modest incomes.
There is plenty of evidence the offer of an employer contribution can be a key
determinant of whether employees take out a pension, and compulsory employer
contributions could make a real difference to the take-up of stakeholder.
"A move from final salary
to money purchase schemes is bad for some employees but good for others. But a
reduction in overall rates of employer contributions is bad news for all
employees. The Government must take an urgent look at strategies to increase
employer contributions and look seriously at compulsion if a strategy of
incentives fails to achieve that goal.
Ian McCartney MP, Minister
"At the moment, it seems
everybody has a plan for pensions policy. We are hearing too many quick-fix
ideas that could leave tomorrow’s pensioners out of pocket.
"I believe the structure
of pensions now in place after our reforms, which will be completed with the
introduction of Pension Credit, is fundamentally sound.
"For various good reasons,
layers of regulations had been loaded onto the pension regime resulting in too
much red tape. That is why we started a radical review of regulation with the
aim of simplifying the system. Alistair Darling will receive the report in June
and set out proposals on which the Government will consult.
"Employers are key to
these plans and we hope they will join us to cut back on regulation that holds
them back, which is expensive in time, money and resources. If employers show
the commitment to their workforce by contributing in their future, there is a
high probability that this commitment will be reciprocated. The results will be
seen through improved morale and help with recruitment and retention.
"We must preserve the
powerful partnership between the Government and individuals in which the state
pension provides the main building blocks of income in retirement, and that
individuals boost that income by contributing to private schemes or the State
"Our commitment to the
basic state pension was underlined this month when it rose by another £3 a week
for a single pensioner and £4.80 for a couple. It is in order to strengthen
this partnership that we have introduced the stakeholder pension to encourage
those on moderate and higher earnings to put more towards their retirement.
"The new Pension Credit
will ensure people see a reward for their thrift by receiving a top-up to their
pension. When it is introduced from October 2003 there will be a simple
assessment of income in order to calculate individuals’ eligibility.
"I began by warning that
so-called easy solutions often prove very costly, but it has been true for a
long time now that most people probably ought to be saving a lot more than they
actually do, especially now we are living longer.
"That’s one of the reasons
why we are introducing pension forecasts, so that within five years most people
will receive an annual statement that will tell them how much – or in too many
cases – how little they will get in retirement."
CHANGING FACE OF PENSIONS
Since the 1960s, pensions have
changed in all manner of ways. Here’s a brief list of what has happened:
The Graduated Retirement Benefit
Plans for a second tier put on hold
SERPs offered 25 per cent of the best 20 years’ earnings, regardless of any
breaks for childcare or unemployment
SERPS downgraded to 20 per cent of an individual’s working life. Low earnings
naturally decreased the end amount
The Pensions Act 1995 introduced the minimum funding requirement (MFR) to help
make occupational pension schemes more secure
Section 3 of the Welfare Reform and Pensions Act sets out that employers must
offer staff relevant access to a registered stakeholder pension scheme
The Stakeholder Pension Schemes Regulations 2000. Employers are exempt if they
have fewer than five staff and offer certain personal pension schemes. Under
section 23 a number of employees are also exempt
● Stakeholder pensions come into being (April)
● Government announces a review of private pension legislation
● State Pension Credit Bill (November) introduced to Parliament. Provides
a new Pension Credit for persons aged 60 and over to ensure that people who
have saved for their retirement will be rewarded for their thrift
● Reform of the Minimum Funding Requirement (MFR) to move towards the
position of more sustainable funding. Also increases protection for pension
scheme members where an employer decides to wind a scheme up (February)
● FRS17. New accounting rules that highlight pension fund deficits in
company accounts (February)
● New Winding Up regulations for Occupational Pension Schemes announced.
Due to come into force from 1 April (March)
● Ian McCartney, Minister for Pensions, announces a package of measures
to reduce the administrative burden on pension schemes. “Simplification of
Contracting Out” includes measures that remove the need to produce actuarial
certificates every three years (March)
● The State Second Pension – a version of SERPS with added extras for low