November 8th, 2009

The previous two newsletters were devoted to IBM's plan to close its final salary schemes to current employees.  This one reverts to the previous practice of considering all categories of scheme member.  The new part for actives is on this separate page.

PROSPECTS FOR PENSIONERS

Now that the economic situation has somewhat stabilised, it makes sense to consider how the pensions picture has changed.  The good news is that the Government has held firm on the principle that pension already earned should be delivered.  You might think that was an obvious minimum but companies are finding it a burden - they promised a pension for life and find lifetimes are longer than they thought.  Just recently they have found that the assets stored in pension funds were worth less than they thought, and there are doubts about whether the future returns on those assets will match what companies hope for.  (Those of you who are comfortable with monetary amounts measured in trillions will  find something here. ).

So it was no surprise to find proposals being made that undermined the principle.  Principally under attack were the regulations that provide a measure of inflation protection for pensions. (Limited Price Indexation).  The proposals came in two varieties, those that would reduce/remove the protection for existing pensions, and those which meant future pensioners could not rely on the get-what-you earned principle.   Proposals of the first variety have been essentially dismissed.  The chairman of the National Association of Pension Funds (the largest organisation of pension providers and their entourage) has recently said "We have promised ourselves more than we can afford, we should look for ways to negotiate down benefit promises." but he has also said “But there is confusion. People think we’re saying you should be able to diminish existing benefits”.

Thus the immediate picture is that economic crisis is not going provoke any panic changes in the regulations that would undermine earned pensions.  However, there is another effect which threatens the value of pensions.  The regulations only protect against inflation up to a point (and the C-Plan rules for pension earned before April 1997 protect even less) so future inflation remains a crucial issue, as it was before the "crunch".  What has changed is the thinking about what to expect.  In the short term economic problems reduce inflation, because consumers are less willing to buy at higher prices.  In the longer term the national and international measures taken to blunt the economic problems will come through.  One can see that these are inflationary pressures by considering "who gains?".   Inflation harms savers and helps those in debt (the value of the the debt reduces; where the amount of the debt stays the same it becomes less relative to the spiralling amounts elsewhere).  Our government has become a debtor to an unprecedented extent.  Those debts pale with inflation.  The effect on companies depends on whether they can sell at higher prices (or keep salaries down) but at least for pension schemes like ours, the company gains from inflation (the value of pensions going down means the value of what the pension fund pays out goes down and the value of what the company has to put into the fund goes down.)  In the UK, the Bank of England is formally responsible for controlling inflation but the question being asked is whether it will be asked (and able) to do so when other powerful decision makers would be advantaged by higher inflation.  Individuals can assess for themselves, but there are good grounds for saying that the future values of existing  pensions are more at risk than they were before the crisis.

PROSPECTS FOR DEFERREDS

Pensions deferred are entirely already earned so the principle applies that what crystallised at deferment should be delivered.  The regulations about inflation protection are comparatively strong.  Capping does not apply on the basis of each year, it applies to the whole period before the pension is taken.  So a particular year of 10% inflation might not harm, provided the compound rate over the whole period was no more than the 5% cap.  (There are exceptions - some N-Plan pension derived from early years is not revalued at all.  For very recent service the 5% number is replaced by 2.5%.)    

Early retirement has always been an expensive option for deferreds, although it can be an important option for N-Planners because there is no N-Plan spouse pension if death is before the pension is in payment.  The early retirement reduction may not represent "fair value" (a proper balance with the chances of the pension being paid for longer), depending on the trust's choice of parameters for the calculation.

PROSPECTS FOR THE STATE PENSION

The basic UK state pension is equivalent to some 16% of the average wage.  This puts it low in the league table for state pensions internationally; the OECD 2009 review says "Public pensions in the UK are projected to provide the lowest pensions relative to individual earnings of OECD countries."  Plans for improvement have been in place for several years - a linking of the state pension to earnings rather than prices, with that linking starting before 2015.   This plan comes with an increase in the age at which the pension is paid.   These plans had all-party agreement when they were announced although some cracks are now appearing.

The linkage remains agreed, perhaps because it will not necessarily be expensive.  Earnings have historically risen faster than prices but may not continue to do so.  That is why proponents of a higher state pension now refer to linking with the higher of prices and earnings.  (That is something the government has not promised).

The higher age before receiving the state pension had wide acceptance because it fitted with the trend for living longer.  But it has become a political issue because (a) it less disadvantages the affluent (who can expect to live longer while getting it) and (b) raising the age sooner would reduce the state pension cost (unless it had to be compensated for by other poverty relief measures).   However, political contention about the dates when the age for the state pension will increase is dwarfed by the bigger concern over whether the elderly will find jobs before they get to the state pension age.  Political parties profess distaste for regulation, but the attitude of employers is such that without regulation there will not be such jobs.

The state pension also has other interactions with social policy - can the plan for Personal Accounts ( inducing the lower paid to join a money purchase scheme by enrolling them by default) succeed if people are concerned they will be means-tested, and the pension they save for will just lead to a reduction in their benefits? 

State Pension age and enforceable retirement age also interact because of the risk of creating a class of people too old for work and too young for a state pension.  In the UK, a worker can see their employment end at the age of 65 without any redundancy payment - even if they do not want to retire. A High Court challenge to this by "Age Concern and Help the Aged" failed but the judge made it clear that was only because the government had agreed to a review in 2010.  "I cannot presently see how 65 could remain as a [default retirement age] after the review," the judgement said.