Decisions - Longevity - making retirement work

The English language is rich in hoary old sayings like ‘now’t for now’t’, or the impossibility of extracting red corpuscles from a rock.

We feel the truth of these bits of wisdom in our bones but, in some strange way, they have a tendency to vanish when the mind turns to musing on retirement.

Pensions are founded on a simple belief in the magic of compound arithmetic. Put a little aside and it will grow into a glorious mountain of cash decades later. However, take this multiplying factor out of the equation. Imagine, instead, that every pound you are ever going to need in your retirement will have to be set aside during your working life. The whole business of saving for one’s retirement, on these terms, will rapidly seem like an incredible grind.

If you add to this picture the notion of increasing longevity, the picture tends to get worse. Trying to save a sufficient sum in 30 years to retire for 30 years does not seem a particularly achievable task, in these terms. The very notion of retirement becomes moot quickly.

Which brings us to the Turner report on pensions, which summarises the necessity of either retiring later, possibly much later, or saving harder if we want a decent pension. Longevity and the probability of low returns on investment being the norm for decades to come are at the root of these tough alternatives.

Of course, this mental exercise, deleting the compounding effect and then seeing what is required on a pound-for-pound basis, presents too stark a picture. The investment industry can still generate positive returns over the long term – just not positive enough to bail out the dreams of the overly credulous.

Bob Scott, a partner in actuarial firm Lane Clark & Peacock, observes that while it is nice to know our chances of living longer are improving steadily, longevity is bad news for companies. The firm’s latest research, Accounting for Pensions, UK and Europe, Annual Survey 2004, highlights just how bad it is.

The survey focuses on the published pensions information from FTSE-100 companies, and this year includes the 50 top European companies as well. It makes fairly grim reading even without adjusting the figures for longevity. FTSE-100 companies are still deep in the mire as far as funding their final salary schemes are concerned.

According to the survey, FTSE companies on average doubled their contributions to member schemes through the last year and paid in 50% more than the FRS 17 value of pension benefits earned by their employees over the year. Nevertheless, this substantial increase in contributions, together with a marked upturn in the world’s stock markets, still left them only able to improve their debt position by £4 for each £100 of liability owed by the fund.

Clearly, any improvement is welcomed. But, according to the survey, FTSE companies still have a £20bn shortfall between what their companies have promised to pay members and the funds that are actually at their disposal. They finished 2004 with £84 in funds for each £100 of liability, up from £80 of cover in 2003, but still woefully in arrears.

To make matters worse, many of these companies have not updated their liability to reflect the impact of the latest mortality figures on their funds. “Reflecting the findings of the latest longevity research could add a further £20bn deficit to the balance sheets of FTSE companies,” Scott notes.

As if being £40bn adrift in their funds were not bad enough, Lane Clark & Peacock argues in its report that because the yield on eurobonds is lower than the yield on sterling, if the UK were to give up the pound for the euro, matters would get worse. A further £20bn, in FRS 17 terms, would be added to corporate pension fund liabilities, taking the total deficit to about £60bn. To put this in context, the survey found that even at the £20bn deficit mark, some 10 FTSE companies covered by the survey reported FRS 17 deficits in excess of 25% of their market capitalisation.

One has to wonder with some awe just how bleak the position would be if the figures were indeed recast to show the effects of longevity and Britain joining the euro.

Deborah Cooper, senior research actuary at Mercer Human Resource Consulting, points out that although people’s best expectations of longevity have only gone up some three or four years over the last 30 years, these three or four years represent a significant increase of life after retirement. “People tend to think of the longevity statistics in terms of birth and death. However, for retirement planning, the significant parameters are the moment of retirement until death. An increase on the scale we are talking about is very substantial and has an impact on pension providers, employers and everyone going on pension,” she explains.

For Cooper, there is only one sensible answer. Pension schemes just won’t be able to square the circle and deliver a decent pension if the balance between time worked and time retired is not corrected. “Working longer is the only answer,” she says. But whether society can deliver jobs in sufficient numbers to keep pensioners employed remains to be seen.