Pensioning off company schemes

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Pensioning off company schemes

Financial Times

Aug 11, 2003

It is easy to be nostalgic about final salary, or defined benefit, company pension schemes. Millions of people derive retirement income from them; hundreds of companies have used early retirement to ease restructuring.

But too many feathers have been plucked from the golden goose. Governments have removed tax advantages, employers have taken too many contributions holidays and members have been living longer. The goose was, in any case, hatched in a paternalistic era, when breadwinners had a job for life. It is ill-suited to a mobile, flexible workforce. Hence the switch to defined contributions schemes, which do not guarantee results - bringing home the risks to individuals.

The problem lies in the big legacy schemes at companies such as BAE Systems, British Airways, BT Group and Imperial Chemical Industries. Actuaries Lane Clark & Peacock put the funding shortfall in schemes attached to FTSE 100 companies at £55bn. Many are too dependent on a sharp rise in stock markets to close the assets to liabilities gap. Otherwise, their promises may be undeliverable.

The sums involved can be eyebrow-raising: BP is putting $2bn into its US fund. Most companies are taking the less dramatic route of increasing annual contributions. But outside the BP league even £50m extra a year is significant - and might otherwise have been reinvested or paid as dividends.

The government addressed some of the issues in a recent report on occupational pensions. But its main proposals for member protection sound better than they are, perpetuating a false sense of security.

Take the Pensions Protection Fund. To provide adequate insurance it should have been set up decades ago, like the US Pension Benefit Guaranty Corporation. But even this model has run up a deficit as the calls on it have escalated. To avoid the good paying for the bad, premiums must reflect risk - but that means high charges for companies whose priority should be to repair their own deficits.

A better solution would be the Dutch model, with more rigorous oversight of the way schemes are run but little or no safety net. The UK is certainly headed down the route of tighter regulation. A solvent employer will be allowed to wind up a scheme only if promised benefits are fully funded; a new pensions regulator will adopt a much more active stance.

The hard work is yet to come, and it needs to focus on liabilities. The most helpful government measure is the halving of pensions inflation-proofing to 2.5 per cent. Employers and trustees will need to negotiate further modifications to promises where the sums involved threaten a company's health.

To avoid killing the goose, employers and scheme members - increasingly not the current workforce - must swap the nostalgia for a sense of reality.