The January 1991 "Pension Matters 2" is a difficult document to optically read; it has text flowed around graphics and headings that cross pages. The foreword and the article on AVC's are not included here. What is described as "Current Legislation" did not come into effect until 1996. The differences from what IBM says now are described elsewhere.
WHY CAN'T PENSION PAYMENT BE INDEX LINKED?
The answer is simple. Affordability. In the UK funding pensions falls significantly on the companies which sponsor contributory or non≠contributory pension funds and the funding costs are very high. For example, IBM UK contributed £66 million to the pension fund in 1990. This represented a significant percentage of IBM's total expenses, and ultimately affected profit.
To add the cost of a guarantee, linking pensions to inflation would involve funding well beyond affordable levels and could jeopardise the future health of IBM, which would be to the detriment of all stakeholders - not least IBM's employees and pensioners
WHAT ABOUT CURRENT LEGISLATION?
Pension funds will be required to provide a guaranteed increase to cover inflation up to a maximum of 5% for pensions accrued in future periods of service. It is, however, important to stress the maximum of 5% and the fact that it relates only to future accrued entitlement. Therefore, the benefit will be insignificant for those retiring in the short term.
The cost of funding this guarantee, however , is significant. And the ongoing cost for a pension fund similar to that of IBM UK would be in excess of £10 million per annum. Some companies will be unable to afford this and will have to seek alternatives - ranging from increased employee contributions, to the extreme action of totally changing the nature of the pension plans.
This might be, for example, changing from a final salary related benefit, where the benefits are certain and the cost uncertain, to a money purchase benefit, where the cost is certain but the benefits are uncertain because they are subject to future investment performance.
WHY CAN SOME PENSION FUNDS PAY FOR INFLATION INCREASES?
Some pension funds have surplus assets enabling them to make pension increases in line with inflation. Such funds are in surplus for two reasons. Firstly, they were at a level of maturity in the late 1970s when their asset base was firmly established to meet future liabilities. This would be the characteristic of an older `industry with a significant number of retirees. With the exceptional investment performance of the 1980s, their assets grew well in excess of their liabilities, thereby producing the surplus.
Secondly, companies with high attrition, or redundancies, would reduce their liabilities as a result of employee turnover. The reduction in pension liability would accordingly produce surplus assets
WHY CAN'T THE IBM PENSION FUND DO THE SAME?
The IBM pension fund does not share the above characteristics. It is a relatively immature fund and the company does not have high attrition, or redundancies. The fund is not, therefore, in surplus. Consequently, there are no assets available within the pension fund itself to guarantee pension increases.
WHAT COMFORT IS THERE FOR CURRENT AND FUTURE PENSIONERS?
Let us look at IBM UK's record, over the past 10 years, in making ex gratia pensions increases funded by the company.
This indicates that the impact of inflation on pensioners has been considerably reduced and reflects the company's awareness of the importance of the issue and an on going resolve to seek to provide protection. It is, however, costly. The cost of funding these levels of increase is approximately £13 million per annum. Additionally, in 1990, attention was focussed on pre - 1983 retirees who did not have the opportunity to join the C Plan, with its improved pension. Most of these retirees, who were on low incomes, received a special increase in April 1990 in addition to the general increase above. This was funded by IBM UK at a cost of £1 million. Therefore, for the reasons mentioned it is not possible for discretionary increases to be guaranteed. However, IBM's record is impressive and while it would be unwise to assume increases at these levels indefinitely, the company will continue to review the need for future increases - subject to inflation rates and affordability.
WHAT ACTION CAN YOU TAKE?
One thing is sure - inflation will not go away - but there are some actions that individuals can take to alleviate the effect of inflation.
Firstly, ensure that on going expenditure commitments after retirement are realistically balanced with potential income, leaving a little left over for unexpected events. Secondly, well in advance of retirement, a conscious decision should be taken to contribute to a voluntary pension plan so that this additional pension can be used as a cushion against the effects of inflation on your retirement income. This is particularly important, requiring action now and on going.
The following article should help you take some positive action. If you are uncertain, however, you should consult an independent financial adviser.