Black-hole sums: the pensions industry is in dire straits and the cost of providing employees with a decent retirement income is spiralling. Cathy Hayward considers the alternatives available to finance directors faced with fund deficits and a stock market showing few signs of revival.
| Author | Hayward, Cathy |
| Position | Finance Pensions |
More than 80 per cent of us spend our working lives fantasising about early retirement, according to a survey by the Chartered Institute of Personnel and Development. The idea of a permanent holiday sipping G&Ts in sunnier climes might help us to get through the daily grind, but a crisis in the pensions industry means that many people could find there's barely enough in the fund to justify buying a cuppa at the local cafe, let alone cocktails in the Med. And, for the finance directors who are charged with steering their firms' pension funds through this crisis, a profitable early retirement must seem like a distant dream.
The massive gap between what pension schemes hold in their coffers and what they have to pay out to members is widening by the day. Last month Morgan Stanley estimated that there was an 85 billion [pounds sterling] hole in the pension accounts of the FTSE 100, with nine out of 10 firms running deficits. Even big names such as Sainsbury's have had their credit ratings put under review by Standard & Poor's because of growing shortfalls. BA and Rolls-Royce, among others, are facing bigger pension deficits than their market capitalisation, yet five years ago few funds were in trouble.
The National Association of Pension Funds estimates that the value of UK pension funds plunged by more than 250 million [pounds sterling] last year. There are several reasons for this, but the main one has been the dramatic fall in the value of equities over the past three years. Pension funds depend on steady stock market returns to pay policy-holders and, when share prices fall, they struggle to meet their obligations. Trade unions argue that the payment holidays that companies took in the stock market boom of the late 1990s--believed to be worth around 30 billion [pounds sterling]--have exacerbated the problem. Gordon Brown's abolition of dividend tax credits in 1997, which amounted to 20 per cent of the gross dividends paid to pension schemes, has also affected the industry to the tune of 5 billion [pounds sterling] a year.
Advances in medicine mean that we are living longer and longer: between 1980 and 2000 the average life expectancy rose by four years for men and five years for women. And we want to retire earlier, of course, which means that the industry has to support more pensioners for longer.
Richard Murphy, co-author of People's Pensions: New Thinking for the 21st Century, (New Economics Foundation, 2003), believes that the widespread mishandling of funds has also contributed to the crisis. "Final-salary schemes are closing because the funds they invested in have been poorly managed--a fact not helped by legislation that encouraged payment holidays," he says.
Fund trustees have also been criticised for being underqualified. Research published last year by Watson Wyatt and Cranfield School of Management revealed that few trustees had an investment qualification or a Pensions Management Institute designation. Member-nominated trustees were even less well equipped: a third had no relevant credentials. Their performance was also poorly monitored, according to the research.
Whatever the reasons behind the crisis, accounting standard FRS17 has made the underfunding problem more obvious. FRS17 forces companies to account for pensions as assets or liabilities on the balance sheet and produces a snapshot based on market valuation. Unilever admitted that the hole in its pension scheme widened from 1.58 billion [pounds sterling] to 2.2 billion [pounds sterling] in February under FRS17. Lloyds TSB announced a 2.9 billion [pounds sterling] pensions deficit at the end of last year. But chief executive Peter Ellwood, who is due to retire at the end of this month, says that on an actuarial basis the bank's fund was at break-even point.
The economic climate in which many of these pension schemes were set up was very different from today's. In the 1970s long-term interest rates were high, there were no guaranteed pension increases, no early-leave protection and advance corporation tax could be claimed on equity dividends. All that has changed and the cost of providing benefits is higher, says Feargus Mitchell, partner in human capital advisory services at Deloitte and Touche. He calculates that in the 1970s the total cost of pension benefits was 15 per cent of total pay, of which 5 per cent was borne by the employee and 10 per cent by the employer. Today it is more like 20 per cent of total pay. Peter Bowers, European partner at Mercer Human Resource Consulting, predicts that costs for a typical final-salary scheme...
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