Page last updated at 07:52 GMT, Thursday, 6 March 2008

Are pension sell-offs a good thing?

Money Talk
By Nick Salter
Barnett Waddingham actuaries

Nick Salter of Barnett Waddingham actuaries
Nick Salter of Barnett Waddingham actuaries
The recent decision by Rank to sell its pension scheme was the latest in a small but growing number of such deals.

The Rank fund, with all its assets and liabilities, was sold to Rothesay Life, which is a wholly-owned subsidiary of Goldman Sachs.

Other companies are expected to do the same and sell their pension schemes to entities set up specifically for the purpose.

Whilst this may well be good for Rank and, indeed, for Goldman Sachs, what impact does it really have on the members of the pension scheme?

Secure retirement

In the UK, defined benefit pension schemes were traditionally set up by employers who wanted to ensure that their employees were able to earn a pension that would allow them to retire with sufficient income to maintain their standard of living.

Employers have become less paternalistic towards their employees

This was, somewhat arbitrarily, often set at two-thirds of the income that a member received whilst working.

The idea was that maybe one-third of one's income whilst working was spent undertaking the job itself - buying work clothing, commuting to work and so on.

Employers set these schemes up voluntarily and created pensions trusts to hold the assets against the promises made.

The voluntary nature of the promise has come under fire from successive governments.

The effect of this is that virtually no employers are setting up defined benefit, or final salary, pension schemes for their staff any longer.

That is because there is now an obligation that, if you do set up a scheme, the members have to be paid their benefits whatever the financial situation of the employer.

Paternalism disappears

Historically, the promise was only as good as the assets in the pension scheme supporting it.

Striking postal workers in York in 2007
Pension changes can be very controversial

These government changes, introduced in good faith, have, as so often, had the equal and opposite effect to the intentions of the government.

Instead of making pensions more secure they have had the effect of reducing the overall pension coverage.

At the same time employers have become less paternalistic towards their employees.

They are happier now to put in place defined contribution pension arrangements.

In these, the employee, rather than the employer, carries all the investment and longevity risks associated with planning for retirement.

Against this background, do these pension buyouts really make any difference to the members of the schemes?

Does it matter that the people standing behind the pension promise are US bankers rather than the UK employer?

On the whole the answer to this is probably not.

A winning situation?

A UK employer may be a good company who understands how to manufacture widgets, operate gambling facilities, or whatever, and that is where the management's attention probably should be focused.

One side wants to get rid of the risk whilst the other side is prepared to take it on

But there are significant risks associated with running a defined benefit pension scheme and the management team needs to be fully familiar with those risks.

To this end it probably makes sense to transfer the pension scheme to a management team that is dedicated to controlling those risks.

This is the reason that these deals happen - one side wants to get rid of the risk whilst the other side is prepared to take it on.

The company selling the risk (Rank last week) places a high value on that risk because it does not like it.

The company that buys the risk places a lower value on it because it understands the risks that it is taking on.

Consequently, any price set between these two values will be a win/win situation for the two companies.

Risks

Does this mean that there is any less security for the member?

What if something goes wrong - the new managers make a hash of the investments or we all live for much longer than was previously expected?

Again, the answer here is that there is probably no greater risk than there was before.

The trustees of the pension scheme need to ensure that the Pensions Regulator is fully informed as to the intended transaction.

One of his main interests will be to ensure that the new backer is at least as strong as the transferring company.

Furthermore, as explained above, the new backers will understand pension risks better and should, theoretically, make fewer mistakes in the operation of the pension scheme.

Changes

Of course, two things do change.

Members of UK pension schemes know that if the pension scheme has insufficient assets they can turn to the UK employer to make good those assets

The first is that the new pension scheme owners will not allow members to earn any further benefit.

In other words, the employees of the transferring company will need to earn future pension benefits through another pension scheme (probably a defined contribution one).

Secondly, the new owners will not provide any benefits that may have been provided on a discretionary basis.

The rules of most UK pension schemes set out the "guaranteed" level of benefits and then specify that the trustees and the employer between them might agree to provide additional benefits in certain circumstances.

It is extremely unlikely that any such discretionary benefits will be provided in the future.

Finally, members of UK pension schemes know that if the pension scheme has insufficient assets they can turn to the UK employer to make good those assets.

Safety net

If the employer cannot fund a scheme properly, then the pension scheme is likely to be eligible to go into the Pension Protection Fund (PPF).

That way members will get compensation at a lower level than the pension benefits they expected, but even so they will not be penniless.

The new owners of UK pension schemes may be employers themselves, stepping into the shoes of the old employer.

In this case members will be equally entitled to compensation in the event that the new owner goes bust.

Or they may be set up as insurance companies in which case members should be entitled to cover, under the Policyholders' Protection Act.

This provides less than full compensation but at a comparable type of level to the PPF.

So, to answer my question above as to whether members should be concerned, I do not think so.

It would be easy to get emotive, but the chances are that it is all rather too late because most employers no longer have a paternalistic view of their employees when it comes to pension provision.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.

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