Warning for the demise of final salary pensions

Saturday 18 December 2010

Warning for the demise of final salary pensions

  • Saga Director-General warns of dangers for UK pension schemes as Pensions Regulator deals with the demise of final salary pensions.
  • Pensions Regulator warnings about the 'end game' for final salary pension schemes and requirements to reduce risk could worsen pension outcomes for all other pension funds
  • As more final salary schemes close and try to reduce risk by switching to bonds or buying annuities, pension outcomes will be worse for defined contribution schemes too.
  • Everyone must wake up to the true cost of pensions - they are far more expensive than we have been led to believe.
  • Government could help by issuing longevity / mortality gilts.

As David Norgrove, outgoing Chairman of the Pensions Regulator, warns of the fundamental changes facing UK pensions, the extent of our pensions crisis is laid bare yet again. Even the man in charge of our pension system has now admitted that final salary pension schemes cannot last. He told the NAPF today that 'we are in the end game for these schemes'.

This actually has implications for all of us, not just members of final salary schemes themselves. It will lead to worse annuity rates for everyone, as more employers seek to buy annuities to 'de-risk' because they will be buying annuities in bulk, adding to demand in the market thus pushing up the price and most people will be pushed into much riskier defined contribution pension schemes, with lower contribution rates as well.

Once a pension scheme is closed to new members, it is only a matter of time before it closes to existing members as well. Sooner or later, employers and workers suddenly realise that one group of the workforce is being treated much better than others. Over time, it will become clear that the costs of pensions for the group of workers still in the final salary scheme has become significantly out of line with the costs of pensions for newer workers. There will then be pressure to treat workers more 'fairly' because otherwise some employees are effectively being paid far more than others to do the same job.

At the moment well over half (58%) of all UK final salary schemes are now closed to new members and one in five is closed to everyone. It will not be too much longer before other schemes close and even Lord Hutton has said that final salary schemes are 'inherently unfair'. Some employers (most notably public sector) could move to career average schemes, but most will choose to reduce their long-term pension risks by switching to money purchase schemes, such as personal pensions or NEST.

This will mean a dramatic worsening in the pension provision for the UK workforce, since final salary schemes offer workers much more generous and safer benefits. However, they have become too expensive for employers and, indeed, most employers no longer continue in existence long enough to be able to underwrite long-term open-ended commitments like pensions. Latest research from the US shows that the average company lasts on 11 years nowadays (compared to around 50 years a few decades ago).

The Pensions Regulator's warnings about the demise of final salary schemes are a timely reminder of the rising costs of pensions. The truth has been hidden from pension savers but reality is starting to hit home.

As more and more fifty-somethings come up to retirement and find their pension has not delivered what they expected - and that annuity rates have made buying pensions vastly more expensive - it is vital that we are honest about the future. A decent pension costs a fortune and most people will need to consider working longer - but part-time, if they want a better old age. A £10,000 a year index-linked pension for a couple aged 65 would cost around £300,000.

The Regulator is right that final salary schemes are dying out, but this has implications for DC pension schemes too. The hundreds of billions of pounds currently invested in final salary schemes will increasingly be looking to reduce risk, as employers will want to take the pension risks off their balance sheets. This means ultimately buying annuities. The Regulator is also encouraging trustees to switch into bond holdings to reduce investment risk.

This is worrying for individuals who will need to buy annuities in future, because there will be much more demand from pension schemes for bulk annuities and more demand is likely to drive up the price. If hundreds of billions of pounds of final salary pension assets switch to bonds and annuities, annuity rates will worsen.

One thing that would help pension schemes and reduce the costs of pensions would be for the Government to issue longevity or mortality bonds. I hope that the Treasury will seriously consider this.

Our pensions crisis is far from over and much more needs to be done to radically rethink both pensions and retirement, before the situation deteriorates even further.


For further information please contact the Saga Press Office on 01303 771529.

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