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THE PENSIONS ARITHMETIC
I wanted to return to the Times’ great pensions scandal because intriguingly two of its own commentators showed dissent. David Aaronovitch questioned on the Tuesday whether Gordon Brown’s scrapping of repayable tax credits was “the main cause of the collapse of our wonderful pensions system”. He went on to say “The Pensions expert Stephen Yeo, a former advisor to David Willetts, was quoted yesterday as saying that he didn’t believe that Mr Brown’s decision was “even in the top three reasons”. Instead he blamed changes by Labour and Tory governments to pension regulations, an unexpected increase in life expectancy and unexpectedly sharp stock market falls”.
Then on Thursday, Anatole Kaletsky wrote “It is certainly true that most of Britain’s traditional private sector pension schemes have been closed to new members during Mr Brown’s tenure as Chancellor and it is also true that government policy has been largely responsible for this decline. But the claim that the 1997 “tax raid” was the main cause of these pension fund closures, or even an important contributory factor, is simply false”.
Mr Kaletsky’s reference to “traditional private sector pension schemes” being closed to new employees is not wholly correct. What has been happening is that industry has been closing final salary pension schemes and replacing them by money purchase schemes. I note from Hansard that even in 1977 Nick Gibb (leading the debate for the Conservatives) acknowledged, “I concede that a minority of pension schemes are final-salary schemes”, which hardly suggests that such schemes were “traditional”.
Personally I think that final salary schemes were a child of the sixties. They relied largely on inflation, so accordingly the real damage that Gordon Brown did to such schemes was to bring inflation under control. Well I’m sorry for the minority that got hurt, but I think that we have all benefited by low rates of inflation under Gordon Brown. I don’t think that we as taxpayers owe any obligation to pensioners whose final salary schemes collapsed as a result, except to the extent that until recently the government forced people into such schemes if the employer ran one and the employee wanted relief for his pension contributions. I think that to compensate for this it would be reasonable for the government to provide those who have lost their pensions with a pension equivalent to the annuity that would have been received had the pensions contributions made by the employee, and a matching contribution by his employer, been invested in a typical money purchase scheme instead of the actual final-salary scheme. Anything above that is the responsibility of those who egged on employees to demand unrealistic final-salary schemes that could in many cases be funded only by forcing the employer into insolvency.
I have been playing around with some figures over Easter (Yes I know that’s pretty sad!). If a person started on a salary of £20,000 40 years ago and his salary increased by say 5% pa. throughout the period he would today be earning £140,780 pa. A two-thirds pension would therefore be £93,853. At the current time a fund of £1,317,000 would be needed to produce a pension of £93,853pa. Throughout his 40 year working life the person would have earned a total of £2,439,000. If the pension fund had also increased in value by 5% pa, contributions equal to 54% of the employee’s salary would have been needed to produce the £1.317million. If it had increased in value by 8% pa. the contributions would have had to be 26% of the person’s salary.
In current conditions it is not easy to generate an investment return of 5% pa let alone 8%. Furthermore, I doubt that many employers put 26% of employees’ salaries into a pension scheme. My impression is that most contributions are in a range of 8% - 15%. Accordingly, absence inflation, the final-salary arithmetic simply does not add up.
Of course some of these assumptions are unrealistic. I doubt that many people started at a £20,000 salary 40 years ago. My salary as a Chartered Accountant in 1965 (42 years ago) when I qualified was only £1,350 per annum. Over a 40-year period, salaries do not increase evenly. They generally spurt for a time and then level off. However what this means is that the pension contributions in early years would be below average, but they are the important contributions which have generated the greatest amount of growth as they have been invested the longest.
Growth rates are not wholly dictated by inflation; they largely depend on growth in equity values, which depend on other factors, such as the popularity of a company’s product, its ability to innovate, its ability to find new markets, supply and demand, etc. Inflation can mask the problems of pedestrian businesses. But final-salary pension schemes are by definition large schemes, which often means that many innovative and high growth stock exchange investments are not available to them, as these are small companies whereas a pension fund needs to invest its money in large chunks.
So why haven’t such pension schemes gone broke earlier? An obvious reason is high stock market growth in the heady 1970’s and 1980’s. But perhaps another reason is that such funds have only started to pay out significant pensions in recent years and that their financial strength was based on assumptions that have proved not to be justified. Another reason is that many such funds penalised early leavers until the government forced transferability of pensions, so that the bulk of the benefit from contributions by such people boosted the growth of the funds for other employees. But a combination of high job mobility and statutory pension fund transferability not only means that such subsidy will not continue but also that the funds needed by the new employer to produce a two-thirds pension in less than 40 years (as many schemes offer) for a person who transfers into the scheme will be correspondingly higher.
Whatever the reason the quickening of the pace of closure of final-salary schemes to new employees seems inevitable. Indeed, the large number of prospective take-overs that are aborted because of the size of the target company’s pension fund deficit, suggests that the sooner all such pension schemes are closed the better it will be for the financial health of Great Britain plc.
ROBERT MAAS
THE PENSIONS ARITHMETIC
I wanted to return to the Times’ great pensions scandal because intriguingly two of its own commentators showed dissent. David Aaronovitch questioned on the Tuesday whether Gordon Brown’s scrapping of repayable tax credits was “the main cause of the collapse of our wonderful pensions system”. He went on to say “The Pensions expert Stephen Yeo, a former advisor to David Willetts, was quoted yesterday as saying that he didn’t believe that Mr Brown’s decision was “even in the top three reasons”. Instead he blamed changes by Labour and Tory governments to pension regulations, an unexpected increase in life expectancy and unexpectedly sharp stock market falls”.
Then on Thursday, Anatole Kaletsky wrote “It is certainly true that most of Britain’s traditional private sector pension schemes have been closed to new members during Mr Brown’s tenure as Chancellor and it is also true that government policy has been largely responsible for this decline. But the claim that the 1997 “tax raid” was the main cause of these pension fund closures, or even an important contributory factor, is simply false”.
Mr Kaletsky’s reference to “traditional private sector pension schemes” being closed to new employees is not wholly correct. What has been happening is that industry has been closing final salary pension schemes and replacing them by money purchase schemes. I note from Hansard that even in 1977 Nick Gibb (leading the debate for the Conservatives) acknowledged, “I concede that a minority of pension schemes are final-salary schemes”, which hardly suggests that such schemes were “traditional”.
Personally I think that final salary schemes were a child of the sixties. They relied largely on inflation, so accordingly the real damage that Gordon Brown did to such schemes was to bring inflation under control. Well I’m sorry for the minority that got hurt, but I think that we have all benefited by low rates of inflation under Gordon Brown. I don’t think that we as taxpayers owe any obligation to pensioners whose final salary schemes collapsed as a result, except to the extent that until recently the government forced people into such schemes if the employer ran one and the employee wanted relief for his pension contributions. I think that to compensate for this it would be reasonable for the government to provide those who have lost their pensions with a pension equivalent to the annuity that would have been received had the pensions contributions made by the employee, and a matching contribution by his employer, been invested in a typical money purchase scheme instead of the actual final-salary scheme. Anything above that is the responsibility of those who egged on employees to demand unrealistic final-salary schemes that could in many cases be funded only by forcing the employer into insolvency.
I have been playing around with some figures over Easter (Yes I know that’s pretty sad!). If a person started on a salary of £20,000 40 years ago and his salary increased by say 5% pa. throughout the period he would today be earning £140,780 pa. A two-thirds pension would therefore be £93,853. At the current time a fund of £1,317,000 would be needed to produce a pension of £93,853pa. Throughout his 40 year working life the person would have earned a total of £2,439,000. If the pension fund had also increased in value by 5% pa, contributions equal to 54% of the employee’s salary would have been needed to produce the £1.317million. If it had increased in value by 8% pa. the contributions would have had to be 26% of the person’s salary.
In current conditions it is not easy to generate an investment return of 5% pa let alone 8%. Furthermore, I doubt that many employers put 26% of employees’ salaries into a pension scheme. My impression is that most contributions are in a range of 8% - 15%. Accordingly, absence inflation, the final-salary arithmetic simply does not add up.
Of course some of these assumptions are unrealistic. I doubt that many people started at a £20,000 salary 40 years ago. My salary as a Chartered Accountant in 1965 (42 years ago) when I qualified was only £1,350 per annum. Over a 40-year period, salaries do not increase evenly. They generally spurt for a time and then level off. However what this means is that the pension contributions in early years would be below average, but they are the important contributions which have generated the greatest amount of growth as they have been invested the longest.
Growth rates are not wholly dictated by inflation; they largely depend on growth in equity values, which depend on other factors, such as the popularity of a company’s product, its ability to innovate, its ability to find new markets, supply and demand, etc. Inflation can mask the problems of pedestrian businesses. But final-salary pension schemes are by definition large schemes, which often means that many innovative and high growth stock exchange investments are not available to them, as these are small companies whereas a pension fund needs to invest its money in large chunks.
So why haven’t such pension schemes gone broke earlier? An obvious reason is high stock market growth in the heady 1970’s and 1980’s. But perhaps another reason is that such funds have only started to pay out significant pensions in recent years and that their financial strength was based on assumptions that have proved not to be justified. Another reason is that many such funds penalised early leavers until the government forced transferability of pensions, so that the bulk of the benefit from contributions by such people boosted the growth of the funds for other employees. But a combination of high job mobility and statutory pension fund transferability not only means that such subsidy will not continue but also that the funds needed by the new employer to produce a two-thirds pension in less than 40 years (as many schemes offer) for a person who transfers into the scheme will be correspondingly higher.
Whatever the reason the quickening of the pace of closure of final-salary schemes to new employees seems inevitable. Indeed, the large number of prospective take-overs that are aborted because of the size of the target company’s pension fund deficit, suggests that the sooner all such pension schemes are closed the better it will be for the financial health of Great Britain plc.
ROBERT MAAS
posted by CBW at 9:44 am
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