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The tinkering that ruined pensions
By Richard Lapthorne
Newsday, April 22 2003
years ago the UK enjoyed a big competitive advantage through its company
pension schemes. They were low-cost, fully funded and responsibly run. Now
we hear talk of a pensions crisis, as if the UK faced the same problems as
France or Germany with their huge state pay-as-you-go schemes. What has
It boils down to an unholy mixture of attacks
on pension fund surpluses and tax credits, the detachment of directors'
interests from those of employees and a mass of other tinkering by
politicians and accountants.
Rewind the film to the 1980s when these
defined-benefit schemes started to come under attack. On the government
side, Nigel Lawson, the chancellor, was concerned about the use of pension
funds - built up through tax-free contributions - to dodge taxes. In 1986
a cap of 5 per cent was put on surpluses.
To recover the surplus, the company would
have to pay 40 per cent tax on it. The alternative was to run down the
surplus by taking contribution holidays. But to get that agreed by the
trustees, benefits were improved.
This set in train a dangerous cycle of
curtailing the build-up of funds while raising members' expectations. Any
expansion of long-term liabilities was set to be exacerbated by increased
At about the same time another little dent
was being made in contributions. The first trimming of advance corporation
tax (ACT) reduced the tax credit that pension funds could claim from
30/70ths of the dividend to 29/71sts. It sounded innocuous enough,
especially as companies earning a growing proportion of profits overseas
were having difficulty offsetting ACT against their actual corporation tax
By the time ACT was abolished by Gordon Brown
in 1997, the related tax credit had shrunk to 20/80ths. It was still worth
£3.5bn a year, on the government's sums. Others put it at £5bn.
The background for these policy shifts was
one of reducing tax rates (and therefore tax credits) while closing
loopholes. But it was also one of growing antipathy towards company
Until the late 1980s, employees could be
forced to join the company pension scheme. That was fine for the
jobs-for-lifers, but it hit early leavers. The world was moving against
paternalistic employers and the immobility of their traditional
workforces, locked in by long-term benefits. Debate swirled around
portable pensions and their transfer values. Younger companies avoided
defined-benefit schemes. Personal pensions were the coming thing.
In boardrooms, the long-held view that
defined-benefit pensions helped retain key staff - right up to director
level - was undermined by the capping of the earnings on which "final
salary" benefits were based. As directors sought other ways to build
up their pension entitlements, their personal interest in the staff scheme
was bound to wane.
On top of that, they received a series of
reminders that the company's promise to stand behind these schemes might
prove a headache as regulators kept moving the goalposts. One example was
the equalisation of pension rights between men and women, stemming from
European directives and court rulings in the Barber and Coloroll cases.
Whatever the moral merits of these suits, the outcome added to the
difficulty of predicting pension fund liabilities.
The law of unintended consequences arising
from tighter regulation is even more amply demonstrated in the changes to
the way pension funds are accounted for.
Robert Maxwell's raid on pension fund assets,
uncovered after his death in 1991, prompted a sledgehammer response.
Following the recommendations of the Goode report, the 1995 Pensions Act
brought in the minimum funding requirement.
Taken with the ratcheting-up of accounting
standards, culminating in FRS 17, attention has switched away from the
assumptions behind a long-term "going concern" valuation to
immediate outcomes: is the fund in surplus or deficit? Does the scheme
flatter profits? If it were wound up today, would there be a "black
The rising level of liabilities - boosted
partly by falling bond yields - and the volatility introduced into asset
values by the use of market prices have changed the course of these two
streams, reducing the links between them. In the face of such
unpredictability and volatility, it is no surprise that boards are shying
away from defined benefit pension schemes.