Pensions are old hat. After Maxwell, Equitable Life, other scandals and declining returns, who wants to bother? People who may want to retire one day, that’s who. And it’s not just employees, either. As a business owner, you should look seriously at using pension scheme legislation to shelter wealth and ensure prosperity when you’ve had enough of working – or even want to spread your wings a bit, having built a secure bedrock of financial strength to fall back on.
But it remains true that pensions have taken a beating. The big ‘final salary’ schemes, which provided a defined benefit of leaving pay based on the number of years worked, have been going to the wall. In March 2011, a report from the National Association of Pension Funds (NAPF) found that bosses are locking employees out of their final salary schemes in record numbers; the report claimed that 17% of private sector bosses had closed their company's pension scheme over the previous five years.
In the public sector, the future of final salary pensions seems equally precarious. Around the same time as the NAPF's aforementioned report, Lord Hutton produced a much-anticipated review of public sector pension schemes, which claimed that final salary packages should be replaced with new schemes, which link entitlement to average career earnings. Many public bodies are likely to follow his advice in the months and years to come.
So where has it all gone wrong for the final salary schemes?
The two major factors have been increased life expectancy and lower interest rates. When mass pension schemes were launched in the 1950s, the average male lived to 67. With retirement at 65, that gave them two years of ‘R&R’ before they shuffled off this mortal coil. Those born in the late 1940s and 1950s – the baby boomers – are expecting to live to around 78. That means retirement funds have to pay out for 13 years, or more than six times of what was originally envisaged. When interest rates were over 10%, the cost was high, but manageable. At today’s levels, many companies have found that the cost is just too great to bear.
Alive and twitching
But the decline in the final sector scheme does not means that the pensions industry, as a whole, is on its knees. They may not be a turn-on to youngsters, thrusting and dynamic players in their 20s, but more experienced staff suddenly find them rather attractive. It happens in their 40s; younger than that and gym membership, childcare, flexible working and paying off education debts are seen as more pressing. That cold morning when you realise you have more office Christmas parties behind you than yet to come brings the stark realisation that the day will come when you’ll be depending on what you’ve done, rather than looking forward to what you can achieve.
Employers currently have an obligation to provide a pension scheme – but it is so light it may not have been noticed. You currently have obligations as an employer to provide a stakeholder pension where you nominate a provider and pensions vehicle for your employees’ contributions, and provide "access" to the scheme.
But this 'light touch' system has met with severe criticism, and things will change in 2012. Under everyone will be obliged to contribute – employers as well as employees. There will be no option or chance to merely pay lip service. Instead of merely offering access, employers with five staff or more will have to arrange for the automatic entitlement of their employees in a qualifying scheme, and make contributions to each employee's pension pot.
Incentive over cost
The fact that compulsion is being introduced, or extended, emphasises that many businesses see pension schemes as additional costs, rather than as a way of attracting or retaining staff. Schemes have their part to play, but their value depends on the demographics of the workforce, who the employer wants to attract and the image they want to project.
With the publicity there has been over the past few years, there can be no doubt that the most attractive schemes are ‘defined benefits’ – those that pay a percentage of final salary for each year of the individual’s employment. They began in the Civil Service and spread en masse to the private sector in the 1950s.
Every large employer worth its salt offered such an arrangement to its staff. With the combined assault of increased life expectancy, reduced investment returns and the end of compulsion to join, which happened during Mrs Thatcher’s reign, schemes were left without the influx of young blood who contributed for years before reaching entitlement. So they simply became too expensive.
As a result, those defined benefit schemes in the private sector have been closing rapidly.
Statistics from the Association of Consulting Actuaries shows that, between 1995 and 2008, the number of British private sector workers with final salary pensions dropped from five million to just 900,000.
The dwindling number of final salary pensions are mostly maintained by very big organisations, such as oil companies and the defence industries. On the whole, the public sector generally remains the last bastion of defined benefit; it has the advantage that the taxpayer is footing the bill, rather than shareholders or customers.
But that hasn’t meant the end of pension schemes, rather a shift to ‘defined contribution’ arrangements, where employers know how much they will pay – X% of the payroll. So the burden of risk has been shifted to employees, who don’t know what level of income their pension fund will buy them in the years to come.
“Companies that offer pension schemes for their employees are incredibly appealing to prospective staff, and are better positioned when it comes to retention,” says Clare.
“Pension provision really depends on the company’s circumstances and objectives. These days, virtually all new schemes are set up on a defined contribution basis. This doesn’t mean they are inferior, but the level of company contributions to defined contribution schemes typically tends to be lower than to defined benefit schemes. Good levels of contributions are key.”
2012: a brave new world
Companies will only be able to opt-out of the compulsory state-sponsored personal accounts scheme if they are providing something at least equal. So what will that be? Well, it’s hard to say, as the proposals are not yet finalised.
They currently talk of the employers’ minimum contribution going to 3% ‘of earnings’, which is a difficult calculation if earnings vary. It's also important to note that, although the scheme takes effect next year, individual employees' responsibilities will be phased in gradually over the next four years, and will ultimately depend on the size of the employer.
Although there may well be some loose ends to tie up, and some points of confusion to iron out, one thing will be very much easier;
the obligations of trustees. A number of companies are put off establishing schemes because of the onerous responsibilities imposed by the Pensions Act 1995 (and subsequent legislation), which was enacted in the post-Maxwell world. Trustees used to simply get together every month or so, review performance, take advice from the insurance company or other pension provider/manager, and take appropriate action.
Grant Lore, director and pensions manager of the Occupational Pensions Defence Union (OPDU), told us about the "weight of regulation" facing employers who have run pension schemes for some time, adding:
“They (the employers) are faced with a greater weight of responsibility of funding and valuation of schemes. For organisations like medical or pharmaceutical companies, which are used to collecting data, it’s not so surprising. For a concept design company, on the other hand, it can come as a huge shock.
“Coupled with reduced investment returns and increased life expectancy, plus the accounting requirements, it’s a much more challenging environment. In the past, actuaries were allowed to use 20-year projections to ameliorate deficits. The Pensions Regulator now uses a 10-year trigger. In the worst case, you can find trustees and employers in outright opposition, where they should really be acting in co-operation on support and funding.”
Altogether, it’s not surprising that there have been no new defined benefit schemes created for years, other than some set up as a result of a merger or acquisition with the intention of bringing two or more funds together. 2012 will make things a little easier.