The provision of defined benefit pension schemes has been dwindling almost to extinction in Britain over the past 20 years. It used to be the norm that you’d qualify for a pension that was determined by your final salary on retirement and the number of years of service at the company. But these gold standard schemes are rarely offered to new employees anymore and those with existing ones increasingly find theirs at risk of change.
Let’s be clear: there has not just been one pension “thief”. In my view, there has been a coalition of culprits who through their own greed, selfishness and regulatory incompetence have systematically raided workers’ employer’s defined benefit pension funds. Listed on the charge sheet are a muddled assortment of inept and grasping politicians, some misguided accountants and ultra-cautious actuaries, a complacent Bank of England, a docile pension regulator and, finally, increasingly indifferent and uncaring employers.
An employee’s defined benefit pension became the norm after World War II and private sector pensions peaked in 1967 with more than 8m active members. During an employee’s working life, they (and their employer) paid into a “ring-fenced” and safeguarded pension fund. On retirement, the employee received a guaranteed and often inflation-protected pension for life. Better still, all investment risk of the pension fund solely rested with the employer. Any poor returns or losses from dodgy investments within the pension scheme were down to the employer to make good.
But the pension tide has now drastically turned. LCP, a leading international actuarial firm, recently reported that in 1993 “virtually all” FTSE 100 companies offered traditional final salary schemes to new employees. By 2018 “not a single one does”.
Worse, the abolition of these defined benefit schemes is not even being restricted to new employees. Companies are now coming after existing employees too. LCP points out that less than 50% of these FTSE 100 companies now provide “any form of ongoing defined benefit accrual to any of their [existing] UK employees”.
Smash and grab
Politicians from across the political spectrum have played their part in this. In 1988, Margaret Thatcher’s chancellor of the exchequer, Nigel Lawson, imposed a tax on pension fund surpluses in a bid to stop pension schemes taking advantage of excessive tax relief to build up their reserves. This policy change led to many companies taking a “holiday” from contributing to their reserves, in order to avoid this tax. In turn, these pension holidays led to a depletion of rainy day pension fund surpluses.
Initially, this wasn’t a problem. Booming stock markets in the 1990s led to even fatter pension fund surpluses and this proved an irresistible target for the Blairite government that came to power in 1997. The chancellor, Gordon Brown, abolished substantial tax relief on dividends that pension funds received on their investments.
The financial effect of this tax snatch was colossal. It was estimated that the loss of this tax relief had extracted, in total, over £118 billion of income by 2014. If this lost income had been even conservatively invested, pension funds may have benefited by an additional £230 billion.
Other pension bogeymen include some accountants and actuaries. In the late 1990s, there was a major change in both national and international financial reporting standards for company pension schemes – with little thought given to the consequences. For the first time, these new accounting rules (now termed IAS19 and FRS102) required companies to recognise pension fund deficits in their own balance sheets. This soon resulted in multi-billion-pound financial black holes appearing in many company balance sheets, unsettling both boardrooms and shareholders.
Some believed that this was unnecessary. But, unlike other liabilities, these pension scheme deficits can significantly shrink and even disappear by themselves through investment growth over the decades. Nevertheless, employees received little sympathy from accounting regulators – even though accountants should have been fully aware the reporting changes would likely finally sign the death warrant for defined benefit schemes.
Some actuaries were also involved in the pension heist by often making unduly cautious assumptions in determining pension fund deficits. For example, it is now becoming apparent that actuaries previously overestimated pensioners’ life expectancy. However, as LCP now points out, retired employees are failing to live as long as previously expected – meaning pension provision will now be less costly.
Some actuaries and accountants have also often been excessively conservative and highly risk adverse in valuing pension fund liabilities. These liabilities are largely pensions that are, or will be, paid to employees – often 30-40 years in the future. It is often assumed that pension fund investments will consist only of low risk and low interest rate bonds, rather than other assets such as equities and property with greater growth potential. Indeed, the Bank of England has also helped to keep these bond yields low by its prolonged imposition of a low interest rate.
The pensions regulator, meanwhile, has often been reticent about protecting the interests of employees and pensioners. It could, and should, have intervened much earlier to insist companies do more to financially assist struggling pension funds. For example, after retailer BHS’s collapse, MPs suggested that the regulator was asleep on the job in protecting pension fund members.
Finally, many company directors have frequently prioritised the interests of shareholders above members of pension schemes. LCP’s recent figures show that in 2017 FTSE 100 companies paid out £80 billion in dividends to shareholders which “is six times higher than the £13 billion” that they injected into their UK pension schemes.
Instead of defined benefit schemes, most employees are now being offered various types of risky defined contribution schemes. This is where, in one form or another, pensions are solely dependent on the performance of the underlying investments.
It’s no consolation to employees, but it’s highly unlikely that defined schemes will ever be returned. By abolishing their defined benefit schemes, companies have removed their responsibilities for pension scheme investment risks, restricted pension black holes in their balance sheets and abolished the need to provide both regular contributions and one-off cash injections into their schemes.
Switching to defined contribution schemes means companies can reduce their pension contributions and pay higher dividends to shareholders. As a further disincentive to returning to defined benefit schemes, LCP warns of more onerous accounting regulation on the horizon that may push defined benefit pension deficits up even more. Meanwhile, companies have largely washed their hands of pensioners’ financial welfare in retirement. Employees and their pensions will increasingly be at the mercy of financial markets.