RSS feedsIn no other policy area have so many government initiatives turned sour. It is probably fair to say that on pensions they have not got much right as far as the public and companies are concerned. From the Chancellor’s abolition of dividend tax credits in 1997, through to the delayed response to Lord Turner’s proposals for reforming state pensions and the reluctance to bring the generous, but unfunded public sector pensions more in line with the private sector, the authorities have had to endure a sustained barrage of criticism.
But for corporate Britain, the legislation which matters is the Pensions Act 2004, the provisions of which are now starting to bite. Following the failure of several high-profile occupational pension schemes, the government created a new regulatory framework to protect members of employer-organised final salary schemes. It believed that, since pension schemes were private agreements between employer and employee, the taxpayer should not be expected to pick up the tab when a fund fails.
In trying to protect both employee and taxpayer, a system has emerged which, critics claim, is intrusive, expensive and onerous. It will be damaging for companies, employees and shareholders and, in the long-term, is likely to speed the demise of the very schemes the legislation is trying to protect.
The magnitude of the problem can be measured by the difference between the pension promises and the value of the present pension assets. This deficit, according to the official figures for March 2006, is at least £440bn using the strictest test of solvency. Some FTSE companies have a deficit equivalent to 25% or more of market capitalisation, clearly a drag on their activities.
This estimate covers 5,800 schemes that account for 85% of all UK pension liabilities. Independent consultants put the total shortfall for all schemes at £518bn. Some believe another £20bn should be added because life expectancy figures have been underestimated.
Whatever the exact number, it is a big one and bigger than it was two or three years ago. And the factors that contributed to the rise in the deficit are unlikely to go into reverse. As the value of many defined benefits schemes fall below their commitments, companies have understandably tried to switch to defined contribution schemes, initially for new recruits, but now also for existing pensionable staff. The Post Office has recently announced just such a move. The costs are lower and more predictable, but the benefits to members much less generous.
At the heart of the new legislation is a pensions regulator, who potentially could become a significant presence in business life. Ensuring that funds achieve solvency in five-to-ten years is one of the regulator’s key responsibilities and if firms try to achieve the Statutory Funding Obligation sooner rather than later it could well have an impact on dividend policy and capital expenditure, as well as salaries and benefits. Some uncomfortable choices will have to be made.
The Pension Protection Fund (PPF) is the safety net for protecting pensions if the sponsoring employer becomes insolvent. The money will be raised by a levy on companies operating a DB scheme, a sum proportionate to their fund liabilities but adjusted for the financial strength of the business (a ‘risk-based levy’). Already, after just a couple of years, the annual levy has soared from £138m in 2005/06 to £675bn in 2007/08. These charges, particularly on weaker schemes, may push some companies over the edge.
Pre-clearance of merger/takeover deals is the other important area of the regulator’s focus, as J Sainsbury is likely to find out. Fund deficits have already proved a stumbling block in several major deals and the regulator now has the right of veto over any proposal involving a final salary pension scheme. The price of approval could well be an increase in scheme contributions, a situation that will affect equity transactions and other debt-financed takeovers in particular.
As if this were not enough, the government has to reconcile the increasing fragility of private sector pension funding with the gold-plated schemes still available in the public sector. The shortfall has been estimated at anything between £600bn and £1 trillion, but it is not subject to the same solvency tests as private DB schemes. It is funded out of general taxation, with contributions coming from those whose pension expectations have been seriously diminished. Some tentative steps have been made to limit taxpayers’ long-term liability, but an enormous disparity between public and private pension provision remains.
The pensions issue, therefore, cuts across all aspects of economic and business life and few households or businesses will be untouched. Given where we are starting from, it is hard to see how the problem or the potential solutions can be regarded as a plus. There are some questions for which there are no easy answers. Pensions is one of them and the obvious message of work longer and save more will not get many votes.
