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Pensions

Comment 17th July 2010

The Labour government was a major factor in the decline of Final Salary pensions over the past q0 years. The Coalition can change laws to make them more attractive.

Factors Making Final Salary Pensions Less Attractive

  1. Demographics – Aging Population
  2. Allowing Risky Investments
  3. Banning Over-Funding
  4. Showing Pensions As A Liability
  5. Share Collapses

Point 1 – pensioners living longer and a lower birth rate – is not the Government's fault

Point 2 is directly the fault of Westminster. The law was changed to allow pension funds to invested in riskier shares and other investments. Pension fund managers are competitive and went for maximim growth. This exposed pension funds to the 2001 Tech Share Collapse and the 2008 Banking Crisis, both wiping out 50% of the value of some funds. If pensions had stayed invested in Bonds most funds would still be in surplus.

In the run up to the 2001 Tech Share collapse some companies actually wanted to put more into their pension funds, but were banned by Government rules preventing what the Government saw as "over-funding". A few years later and those companies have sadly been proved correct – the funds are now in serious defecit and closed to new entrants.

Also if a pension fund is technically over-funded the company becomes attractive to predators. It can be taken over and run with zero employers pension contribution until the surplus has evaporated. Close the company and the so-called surplus can be "returned" to the new owners.

Company pension funding is formally assessed every 3 years, but under accounting changes introduced in the 1990s, a pension fund defecit has to be shown as a liability on the companies books every time they are published. For companies that have 1/4ly reporting this can have a massive impact on the apparent value of a company every 3 months as the stock market fluctuates. This is despite the reality that pensions are investments accumulated over 40 years and paid out over 15-20 years, enabling them to smooth out short term fluctuations and rely on "underlying value".

The chilling effect of showing short-term shared-price based pension liabilities on company books is that even if a company is well run, stable, profitable, and has a well funded pension fund, the company's official book value can fluctuate wildly. Regardless of how much money the employer has to put in, just this fluctuation makes a Final Salary Scheme threatening.

Most of  these points can be addressed by Government making changes to UK law.

As for demographics, the real figures are not as bad as the scare stories quoted in the papers. One factor is the number of people who could work but do not, and what figure is used for "working population". Secondly the pension age will inevitably rise,even if only to equal Male and Female retirement, improving the Worker:Pensioner ratio. Taking millions of teens out of employment and encouraging them undertake 5 years of Further & Higher Education is a deliberate political decision that has an obvious impact on the size of the workforce. However it makes sense if it increases productivity over a person's lifetime – that increased productivity should be taken into account.

Why does this matter?

WHY ARE FINAL SALARY PENSIONS IMPORTANT?

One major reason is that Defined-Benefit pensions transfer all the risk and management from thousands of full time professionals to millions of amateurs who have neither the time, skill, experience or resources to watch markets daily and rebalance portfolios.

Many people with Defined-Benefit pensions will make poor investment decisions, and never see the full value of their pensions. A significant fraction – between 10% and 25% – will spend their old age in poverty despite having put aside sensible amounts.

With defined benefit pensions the employee cannot get a clear picture of how much they need invested. Pension advisors will hedge projections with so many caveats as to make them meaningless. The employee is therefore left in the dark. By contrast full time pension professionals will have seen the reality of groth figures for 100s or 1000s of people over decades and will know what is realistic.

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