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Will Britain repeat US mistakes?

By Liam Halligan, The Money Telegraph

December 14, 2003

For many Americans, the Pension Benefit Guaranty Corporation represents security in retirement. Since its establishment in 1974, some 785,000 former employees of insolvent companies have received their pension from the PBGC.

However, this quasi-government body, which currently insures the defined benefit (final salary) schemes of 44m US workers, is staring into a financial abyss.

"Three years ago we achieved a $10bn surplus," says Steven Kandarian, the PBGC's executive director. "This year we've had a deficit of almost $11bn. That's five times larger than any previous one-year loss in our 28-year history."

Despite this alarming decline, the PBGC is the template for the UK 's proposed Pension Protection Fund. Whitehall officials visited Kandarian earlier this year, before plans for the UK 's PPF were unveiled.

"We're in a large deficit position," Kandarian says. "In recent years we took on some seriously underfunded pension schemes, primarily in mature industries such as airlines and steel, which dragged down our net worth. If we took on a few more like that, the numbers would deteriorate even quicker."

In America , as in the UK , three years of stock market losses, and rising life expectancy, have seriously undermined company pension funds. So, what does Kandarian advise?

"I'm reluctant to give guidance - given the cultural and social differences," he says with a smile. "But . . . contributions should definitely be risk-based - so unsound funds pay higher premiums."

This advice, like many aspects of the US model, has crossed the Atlantic intact. The PBGC is funded by an annual employer levy of $19 per scheme member, plus an additional $9 per $1,000 of unfunded pension liabilities. The PPF will be funded by employer levies too - similarly split into "headcount" and "risk-based" elements.

The PBGC caps annual payments at $44,000 (25,500). Payouts from the PPF will also be limited to a maximum value - as yet undetermined.

But as Kandarian describes his scheme, the problems he raises should sound an alarm about the PPF - not least that employer levies will be too high, encouraging even more schemes to close.

"At the moment, the levy isn't too bad," he says. "But . . . I can't guarantee this premium will be adequate going forward. And despite the risk-based element, companies with well-funded pensions end up making transfers to those with badly underfunded plans. If these transfers from strong to weak plans become too large then strong companies elect to leave the system."

There is, though, one major difference between the US and British models. Ministers are adamant the PPF won't have government backing, but the PBGC has access to public funds. " Congress would never let us fail," Kandarian says.

There is talk in official circles that the PBGC could be "the next Savings and Loans crisis" - when US taxpayers forked out hundreds of billions of dollars to cover insurance guarantees on deposits at so-called thrift institutions (local banks, a little like British building societies).

If there were a government bail-out, Kandarian says, "in essence, taxpayers would shoulder the burden of paying benefits to the 20 per cent of private-sector workers [with a] defined benefit plan".

This highlights the dangers for the Treasury. Gordon Brown would be damned if he underwrites the PPF and damned if he doesn't - which isn't much of a choice.

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