27 January 2006

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The IBM UK pension schemes have been redesigned.  Employees in the final salary schemes will have a choice between staying final salary and earning pension on a poorer basis, or moving to a money purchase plan with good employer contributions.  Retirees with pre-1997 service will have their pension increases made more reliable but smaller.  More on this is in a separate page.

The topics in this letter are the Turner Report, British Airways, the trend to close Final Salary schemes for existing members, IBM US and IBM UK announcements on pensions, why a buoyant stock market has not put things right, the MED elections and the Pensions Ombudsman.

The documents added to the website since Newsletter 29 are:

On the Turner Report  A viewpoint on Lord Turner's recommendations, from a national organisation representing the members of occupational pension schemes.

British Airways situation  A PowerPoint presentation. (Google Powerpoint if you need a free reader for that format)  This is the British Airways pension position as seen by those opposing change.   Another article and website are related.  The website shows a stronger organisation than AMIPP has achieved, based on "battle hardened" trade union experience with many companies.

You will know about the Turner Report  from the media.  The three big proposals are:

For a better, less means-tested, State Pension in the long term.  (50% of pensioners are already means-tested in some way and without change that rises to 80%). There is a wide consensus in favour of this proposal, although the government is reluctant to commit to the necessary funding.

For a new form of saving, where employees are joined to a DC scheme by default if there is no better scheme available to them.  The scheme (known as Britsaver by analogy with a scheme New Zealand has called Kiwisaver) has contributions of 4% salary from the employee and 3% from the employer.  Tax relief on the employee contribution allows this to be described as "You only have to pay half of what goes into your account".  Britsaver is expected to be much more efficient than pension provision by selling to individuals because it avoids the cost of the sales advice and does not need to support shareholders.  It is opposed, as you would expect, by the insurers who sell individual pensions and by small businesses concerned at the expense.  (The employee can opt-out of Britsaver but the employer can't unless, as with IBM UK, something better is provided.)

Lord Turner proposes that the age at which the State Pension is delivered should be raised, over the long term.  Again there is wide support although it is recognised there is risk of creating a class of poor who are too old to find work and too young to receive a State pension.  Trade unions have concern that manual workers will have been discriminated against because they tend to die younger.

One significant aspect of the Turner Report was in what it did not say - it did not suggest financial assistance from the government for final salary schemes.  Up to that point there had been many calls for the government to "do something" about the demise of final salary schemes. (And there are still a few such calls.)  The Turner Report merely noted that the schemes had and would decline.  Perhaps this signal prompted more urgent thought about closing schemes to new accruals.  This doesn't mean that the schemes go away; they retain all their built up obligations to pay pensions but avoid adding to those obligations.   The first big (FTSE 100) company to do this was Rentokil.  The question now seems to be "when" rather than "whether" genuine final salary schemes will become non-existent.  The pensions media has quotes like "Rentokil's decision was a seminal moment for pensions.  Once one FTSE 100 company has completely closed its DB scheme it gives permission for others to do it too. However it will take much longer than five years".   (About five years was a suggestion from the National Association of Pensions Funds)

There are many variations on how Final Salary schemes can be degraded.  Employee contributions can be raised - one scheme has them at 14% of salary.  Or what proportion of final salary each new year of service provides, the accrual rate, can be changed.  Or, as with IBM UK, the relation between actual salary experience and the salary used for the pension calculation can be changed.

IBM US announced the simplest option for its US scheme - nobody allowed to earn more pension in the final salary scheme.  They would be able to save in a "401(k)" scheme instead.  (There is an account of US approaches to pensions saving in Newsletter 18.)  The US announcement said "In recent years, IBM has been following a global strategy to move
toward defined contribution retirement plans for both existing employees and new hires".  It is this global strategy playing out in practice that we are now seeing.  As you might expect, the rules are different for executives.  It is reported that "When International Business Machines froze its pension plan in early January, thousands of its employees suddenly felt a lot less certain about their retirement security. Samuel Palmisano, IBM chief executive, has no such worries. Palmisano, according to IBM's regulatory filings, will receive an annual pension of $4 million when he retires at age 65."

It is noticeable that the pensions scene remains gloomy despite another highly successful year for pension fund investments. (UK and European equities made a 24% gain in 2005.  Japan better, USA worse)  It was easy to see why extra longevity weakened schemes - pensions were to be paid for longer.  The new downside is in the expected long term returns from "safe" investments where the government is promising to pay.  The 50-year gilt (aka bond) had a real yield (after inflation) of just 0.45% on 18th January, compared with 0.77% at the start of the year.  The government is issuing more bonds and there was so much demand for the one offered on 24th January that it sold at a price matched to 0.46% over inflation.  What has happened is that pension schemes stung by the last crash in their stocks and shares decided that that they would invest more in investments that were more reliable.   Actuaries looked at the expected future and decided that these investments were not going to grow much, so more of them were needed to support the payouts of pensions in the future.  That meant the fund was in worse financial shape, tending to wipe out the gains from the stock market.

In the past two weeks alone the combined FTSE 100 pension deficit has risen by £35billion to £110billion as a result of tumbling yields, according to accountants Deloitte. "When you consider companies topped up their contributions by just an extra £8billion in 2004, you get an idea of the scale of the problem," Stephen Yeo, a partner at actuaries Watson Wyatt said.

It is no wonder that companies are keen to jettison their final salary schemes, rather than relying on rising markets to float them out of trouble.

The problem of reduced expected future returns carries over to other areas.  When buying an annuity from an insurance company you can now expect less pension for the same upfront price.  Potentially, the amount of pension you get from converting a given AVC to pension, from our trust, could diminish.
 

From 6 April 2006 employers will no longer be able to make certain changes to their schemes without first consulting scheme members.  The regulations require employers to consult current and prospective scheme members for "at least" 60 days before any changes can be implemented.  There may well be disputes about what is significant and what "consultation" means. "Consultation" is not defined but the regulations provide that "the relevant employer and any person consulted are under a duty to work in a spirit of co-operation, taking into account the interests of both sides"
 

In Newsletter 29 we gave an update on the fate of the members of occupational pensions schemes that failed before the Pension Protection Fund was in place, and said a report was due from the Parliamentary Ombudsman.  This report has been delayed.  Read what one acknowledged expert has to say about that.

Frank T Cary has died aged 85.  As his obituary says, "When Mr. Cary left IBM, under its then-mandatory policy of retiring executives at 60, the company seemed invincible."

Of the four current trustee-directors, one was ruled too old to continue and one chose not to enter the MED election.  The remaining two (Dave Mitchell, Gavin Wilson) were elected and are joined by Mark Butcher and Lucy Kannengieser.  The participation rate was the lowest ever at 22%, suggesting that the introduction of electronic voting was not a success and/or that potential voters are now less inclined to think their vote could make a difference.  Pension Services will tell candidates where they finished but only tells us who was elected.  It is deducible that the second placed retiree outpolled the third placed employee, or there would not have been two retirees elected.  This has been the pattern of previous elections also - the more successful candidates tend to be retirees.

Employees considering the security of their jobs might want to read what the Daily Telegraph says about offshoring. "An experienced software programmer in India receives £6,600 a year compared with £33,000 for his counterpart in the UK".  Also this example of IBM outsourcing its sackings.

Finally, a footnote about the complaints to the Ombudsman which were of great interest until they were not upheld.  AMIPP argued the Ombudsman had things wrong but it was unable to get them corrected in the High Court because of cost.  Now the same Ombudsman is reported (in Pensions Week 443) to have this view:

[David Laverick] warned that where High Court action was necessary, issues of cost should not pose a problem.  He noted that in the white paper government had said court action was "complex and costly".  Laverick argued "Government action is needed to ensure that lack of finance does not carry with it a consequence of lack of justice".

All very true, but it does nothing to correct the Ombudsman's earlier mistakes!

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