Pension deficit: don't bank on your employer

(Sigh) Lorna - As I've said time upon time, there is no deficit in a final-salary scheme unless and until the scheme starts to wind up - and these days the vast majority of schemes don't. The whole funding structure of a final-salary scheme is based on putting in a small (but significant) amount of money now, and letting compound investment growth provide the funds to pay the members' pensions when they fall due, which could be in 20 or 30 years' time. If you look at a pension scheme as a succession of small cash payments, it starts to look much more affordable.

You are not doing anyone a favour by reporting these scare stories.

Pensions have a part to play in retirement funding - I entirely agree that people should also use ISAs and other savings products, but opting out of your employer's scheme "because pensions are no good any more" loses you the employer's contribution and tax-free growth over and above your annual ISA limit.

Agree with Maverick. Bandying figures around like £295 billion without any explanation or context doesn't help much towards a constructive debate.

Can anyone explain why DB schemes were seen to be affordable for nearly 40 years, but yet now they're being closed at a rate of knots. After all, we've had big market crashes and recessions during that period.

Is it simply a case that, for the most part, employers just don;t care about their employees anymore?

It's not as though the increase in longevity came as a big shock to everyone is it?

S-ville - Defined-benefit schemes 40 years ago were very much plain vanilla - probably no widow's or children's pension, no statutory pension increases after retirement, no revaluation of deferred pensions, possibly even no death-in-service lump sum. Over the last 40 years the legislation has imposed a great deal on pension funds. One by one the "add-ons" look affordable, lumped together they most certainly are not affordable. As one commentator said, "Death by a thousand benefit improvements".

That is before counting the cost of our Gordon's raid on dividend tax relief in 1997 and the knee-jerk reaction in 2003 forcing buy-outs when a scheme winds up. It's not that employers don't care about their employees any more. If you see pensions as "deferred pay", employers can't afford to pay them at that level.

The longevity graph in Northern Europe has been a straight line since 1850. Whatever actuaries may tell you, it shows no signs of levelling-off yet.

As Maverick says (with a big sigh from me too) yet again we seem to have missed the point in this article. The points as outlined by Maverick are absolutely correct so I won't go over the whole thing again.

However, I would make one more point. When pensions began and up until FRS17 and IAS 19 being introduced pension scheme used to take a long term view in their valuation of the liabilities. Now the employer has to show the current value (granted on a prescribed basis) of all the liabilities in their accounts each year. This has had a massive negative impact on the employer's view of DB arrangements. In addition the tPR, in its primary task of protecting the PPF, now insists that funds have enough resources for at least a full buy-out at PPF benefit levels all the time NOT when the liabilities are realised.

This has effectively, together with all the other issues as outlined by Maverick, put the provision of BD pensions way beyond the reach of most employers whether they wanted to continue to provide them or not. In addition this approach has also put DB arrangements beyond the pocket of Public Sector employers (which the rest of us who are not in the public sector and have no chance of having this sort of protection will have to fund through taxes of various hues).

While the powers that be still insist on being close to fully funded at all times for DB arrangements using this insane criteria, never envisaged when these schemes were established, DB will never see a revival in the private sector and will be increasingly under pressure in the public sector.

Dek - Thanks for remembering what should have been one of my main points!

And another thing - small companies' pension schemes are allowed to buy commercial property and lease it back to the employer - so the rent accumulates in the pension fund tax-free. Large companies can't do this - their involvement can only be up to 5% of the value of the pension fund, even if the whole arrangement is on a strict arm's-length basis, using independent valuers. Where is the logic in that? At a stroke the Government could give a boost to commercial property and help UK employers' pension schemes.

We can blame the politicians but ALSO companies who 20+ years ago had built up such huge sums in their pension schemes that they decided to take pension holidays and contribute zilch for several years.

There were also outright thieves like Robert Maxwell (first calledc himself DuMaurier after the cigarettes before he went upmarket to become a rather large instant coffee merchant).

It's hard but not impossible to 'guarantee' a final salary pension sceme based on 20 to 40 years service but we also all know that the likes of Ford and GM in the USA have been crippled by huge pension liabilities which are far in excess of what they have to pay their existing workforce; but if a final salary scheme is properly funded over decades and invested wisely all but rampant future inflation should be adequately taken into account.

The fact that the state guarantees inflation proof public service and state pension schemes is a guarantee that maybe the country can nolonger afford and as we're all in the same boat when the economy sinks.

They should depend on the ability of the economy as a whole and the ability of those that create the real wealth to pay for such generosity.

Dont forget the pensions being creamed by the workers party then the ones after that.

Just a reminder to everyone about the surpluses from 20 years ago.

These surplus positions were based on liabilities that were measured in a significantly different way. If measured in today’s terms they wouldn't have been in surplus in the first place.

Also, there was a tax liability applied to pension schemes if their surplus was too high. Therefore it was not unreasonable for employers to take a contribution holiday if the scheme was deemed to be in surplus under the prevailing valuation criteria of the day; especially if the alternative was to generate a tax liability (which it was) on any additional contributions made.

Don't misunderstand; I agree that there was some very shady goings on by a minority of employers at the time that needed to be addressed but the reaction was totally out of proportion to the issues globally. The bottom line is that the likes of Maxwell were breaking the law as it stood at the time and it was enforcement of the existing regulations that was at issue.

Maverick - just wonder if you have any financial qualifications, as what you describe is a Ponzi scheme. Funds must have sufficient assets on an actuarial basis to pay for the future accrued liabilities. Otherwise, those at the back end of the queue end up losing their shirts.

To ignore this on the basis that the fund is ongoing is irresponsible. Not only would longer life expectancy deplete the fund, but also the labour force may shrink

If you ran a pension scheme based on the fact that current contributions would pay for current pension payments and had no regard for the funding, then you would probably end up behind bars..

Anonymous 2 - No, I don't have any financial qualifications, just 20 years' experience as a pensions lawyer.

Final-salary schemes are not Ponzi schemes (as opposed to the state pension and civil servants' and teachers' pensions, which are). Final-salary schemes maintain a fund. Money goes in from the employer and the members as contributions, and the fund's investment growth is added. The whole lot is mixed up, and when pensions are paid out of the fund there is no way of establishing which bit of money is paying which pension.

As for pension funds having "sufficient assets on an actuarial basis to pay for the future accrued liabilities", if you have had as many dealings as I have with actuaries you will know that no two actuaries will ever come up with the same answer. They all make assumptions on future investment growth and member longevity and dozens of other factors, when one tiny adjustment to one factor can produce a difference of millions of pounds in the scheme's "liabilities". It's a joke among pensions lawyers that actuaries are paid twice as much as lawyers, and always get the answer wrong . . . .

At the end of the day a final-salary pension scheme is a cash-flow of pension payments to the pensioners. How employers fund that (within the legal parameters) is by getting the scheme's trustees to invest the fund so as to produce that cash-flow. Contrary to popular belief, that does not mean putting in all of the necessary money now.

In any case, those at the back end of the queue now have the Pension Protection Fund to give them 90% of their promised pension, subject to a limit of around £30,000 a year. If a pension of £27,000 a year counts as losing your shirt, I'd really like to lose mine . . . . . !

Dear Anonymous 2 - Maverick can very obviously defend his own position. I only hope though that by asking the question whether "...you have any financial qualifications” to Maverick isn't an indication that you do have such qualifications. If you have and are a practicing financial advisor it is hardly surprising the finance industry in general and pension provision in particular has such a limitable reputation.

Dear Dek - yes I do have financial qualifications, but am not an FSA. However, in order to ensure that the companies for which I work survive I have to ensure that they have funds to meet all liabilities. Also the legal accounts have to show such liabilities whether short term or long term. Companies like Enron tried to ignore this.

Maverick is a lawyer, and yet appears to suggest that it is not important if a pension fund goes bust as there is the Pension Protection Fund, financed by other pension funds and backed by the taxpayer. I consider this as irresponsible - another case of spending other people's money - and unbefiiting for a lawyer to suggest. This is like telling people that they can max out on their credit card and then go bankrupt - which led to the financial crisis.

But as he points out there are legal rules to ensure that pension funds are reasonably funded, allowing for market fluctuations and top ups. However, any scheme which relies on current contributions to fund others' payments is a Ponzi scheme.

As Maverick points out the trustees invest the contributions to cover future payments, but they cannot do this if the fund is totally insufficient, and also the investments have to give a return not only to match inflation, but also to cover any average increase in pension years. Therefore, although different actuaries may have some differences, the ball park result is the same.

Therefore, whilst the exact figure of pension deficits may be debatable - a bit higher or a bit lower, any prudent person will realise that if the gap is huge it would be irresponsible to ignore it and assume that it will be alright on the night.

Just because someone has qualifications does not mean they know more than other people.It means they sat through a test but does not mean they understood it. We have all delt with people with qualifications who cant do there jobs without the help of others. People who dont have papers take a lot mor notice of what is going on when it is there money at risk

key board sticking

Anonymous 2

At the risk of putting this too simplistically for such a highly qualified person who obviously experienced the basis that these schemes were set up and how the goal posts have moved over the last 30 to 40 years.

Look at it this way - you buy a house worth £100,000. You put down a deposit of £10,000 and therefore have liabilities of £90,000 (i.e. that's what you owe).

The bank (or building society) says "OK Mr Anonymous you are going to pay this off over the next 20 years, we want £4,500 per year plus interest of £500 making £5,000. The interest might go up and down a bit with interest rates and demand but that is what you will need to pay".

"Fantastic" says you "that will be wonderful".

2 years later your Bank/Building Society (representing in this story changing pension regulations) comes to you and says "By the way although we accept this is a long term position we want you to hold the balance of your liability in your account all the time from now on!!!!"

Point made?

Dek - your "point" is invalid. In the example you give you seem to forget that the borrower has an asset - the house - on the other side of the balance sheet. If you were a company you would show the capital value of the mortgage liability on one side, and the value of the house on the other.

Even a very basic accountancy qualification would cover this. Also in this case the person doing the borrowing is the person who benefits from the house. He is not relying on other people paying off his loan if his funds are insufficient. However, in the case of DB pensions, if the share of the fund does not meet the cost of the annuity ate retirement it is by definition made up fron other people's shares. Hopefully the employer can step in and make up the difference, but if he cannot the fund will go downhill and collapse leaving those who have not retired short changed.

Anonymous 1 - so there is no point in anyone being educated then on the basis that some do not learn? Sounds like sour grapes to me !! :-)

Anonymous 2

I give up you are obviously going to be obtuse whatever analogy I use. It was NOT meant to be a literal comparison. Do you never tell your children stories to make a point?

My point was that the rules for pension provision have changed significantly over the last 30 to 40 years and bare very little resemblance in terms of the capital requirements required under legislation to those in place when BENEVOLENT employers set these schemes up. Basically the move is towards a FULL Buy Out position in terms of asset values under management. This OBVIOUSLY includes PROFIT. The last time I looked a pension scheme is NOT intended to be a profit making organisation.

The reality is that people with your unhelpful approach have been primarily responsible for undermining pension provision and moving the UK from the leading provider of quality pensions to it's working population to a position of significant under provision and one of the poorer pension positions in Europe.

Example - ".....in the case of DB pensions, if the share of the fund does not meet the cost of the annuity ate retirement it is by definition made up from other people's shares. Hopefully the employer can step in and make up the difference...." You know (or should if you are that financially aware) that unless the employer goes to the wall they ALWAYS have to pick-up the shortfall.

This is so full of holes it would make a good sieve.

1. In a DB scheme the trust would normally pay the pension, therefore the annuity rates prevailing at an individuals retirement age are irrelevant.

2. There is NO individual SHARE of the fund in a DB arrangement. I thought you new how schemes were structured!!!

Anonymous 1's point would seem to be that there is a lack of common sense in your response. Can’t say I disagree.

By the way - I didn't say I wasn't a qualified financial adviser now did I !!!!!

Some of us don't find the need to wave our pieces of paper around like flags (yes I have more than one) to justify our opinions.

Pride, Fall and all that.

my point was dont always believe qualified people know what they are talking about .I have seen this time and time again. self taught people are some times more in tune with what is going on are not blinkered to the bull and hype of the areas they work in. My reasons for the short fall are

1 - to long a pensions holliday because of over funding and tax implications if over funded.

2 - gorden brown and co raiding pension funds and not stopping it

3 - The main one. Pigs in the troff, to many big pay rises for years on % pay rises with the highest payed fleasing the pension schemes.there should have been a top cap on the schemes and that would limit the liabilitys.

4 - take overs should always go to the pension regulater and be topped up if taken over forcefully.

5 -common sense again.

just look if you pay very big wages you pay very big pensions. db schemes are very good and why not. these are what i call defered wages so stop knocking them. the higher up the ladder they get share options as well but we dont here that getting slaged off

Anonymous 1 - all valid points to some degree. Can't tell you how many times I have seen senior (favoured) managers/executives getting large pay increases in the last year or two before they retired with a DB pension significantly uplifted on the back of it (this will obviously predominantly stop now under the new LTA and AA provisions). It was a very frustrating aspect of DB arrangements. That is why CARE schemes make a lot more sense. Effectively you get benefits in direct proportion to what was paid into the scheme for you when you earned them. .

Like you I agree that DB arrangements were and are still a fantastic thing. Unfortunately they have been severely wounded by repeated attacks and are now slowly dying on their feet. I can't see any employer (outside the State) wanting to take this sort of hassle onto their shoulders anymore.

Sad but true.