Problems and solutions

Dr Ros Altmann, pensions expert and advisor to the Government sets out the key problems with deferred benefit or final salary pension schemes.

She also gives her potential solutions to the crisis facing the pensions system.

Click on the links to read the The problems and Dr Altmann's possible solutions.

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THE PROBLEMS

• There is no protection in place for people who are not yet retired, when their final salary pension scheme is wound up after employer insolvency.

• Most people think that their pensions are protected, but they are not - even after the 1995 Pension Act, the introduction of the Minimum Funding Requirement (MFR), Myners Review and Pickering Report, an employer's final salary scheme may provide no pension at all for members who have contributed loyally for 30 years or more.

• The final salary pension is not 'guaranteed' by employers at all for those who are still working - people do not generally realise this. If the employer decides to wind up the scheme, or becomes insolvent, they may get much reduced pensions or even no pension at all.

  

  The 1995 Pensions Act was brought in after the Robert Maxwell scandal
  

• Pensioners already retired (even Directors who have taken early retirement) have priority over deferred pensioners. Those who are still working may not even get their own contributions back if the assets in the scheme are insufficient on wind-up, after having to pay pensioners first.

  One of the big problems is that the 1995 Pensions Act (which was designed to protect pensions after the Maxwell case) introduced a particular 'order of priority' which must be followed, when a scheme's employer becomes insolvent and there are not enough assets in the fund.

  This order of priority says that the assets of the fund must be spent on pensions already in payment, plus their full inflation-linked increases, before the pension promises of members who have not yet started drawing their pension can be paid.

  
  

  At the moment, even fully solvent employers can just decide to wind up their pension schemes

  
  

  Dr Ros Altmann

• At the moment, even fully solvent employers can just decide to wind up their pension schemes. If they do not want to keep running their final salary scheme, it is quite easy for them to just walk away from their liabilities.

  Employers in the past have generally referred to their schemes as 'guaranteed' pensions, but the law currently allows them to just decide to wind up the scheme and leave members short-changed.

  The law only requires an employer to pay in to their scheme enough to provide pensions for members who have not yet retired at a level specified by what is called the 'Minimum Funding Requirement' or 'MFR'.

  In fact, at the moment, the funding level will only buy about 40% of the pensions promised to workers under age 45. Even if the employer can well afford to pay in more, the law does not require them to.

  
  

  People can contribute for over 30 years and end up with no pension

  
  

  Dr Ros Altmann

• Government rules prevent people from contributing to a private pension, if they are in an employer's scheme. This means most people have had no way of providing any other retirement income for themselves, yet their pension contributions are not properly protected.

  People can contribute for over 30 years and end up with no pension. This is like encouraging people to put all their money into one share on the stock market. However strong the company is, no-one would ever be advised to do this with their life savings (and their job), but that is what happens when an employee is in their employers final salary scheme.

  If they cannot hold more than one pension (and this only became possible last year- and still only for some people, not all) they cannot diversify their retirement assets.

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POSSIBLE SOLUTIONS

There are changes we can make to solve this problem. Policies to provide some safeguards need to be divided into two areas. Firstly to protect members of schemes whose employers become insolvent and secondly, to protect members of schemes whose employers decided to wind the scheme up, but remain solvent.

For schemes winding up due to employer insolvency:

• Mutual insurance (to provide at least a minimum level of pension to all final salary scheme members on insolvency). An insurance levy - similar to the ABTA scheme for travel agents - which would guarantee at least some minimum level of pension for all final salary pension scheme members - whether retired or not.

  Other financial products are protected, such as bank accounts up to about £30,000 or financial services compensation up to about £48,000, but pension contributions are not.

• A change of priority order on wind-up. It would seem fairer to suggest that the scheme's assets should be shared among all the members in a more equitable manner.

  Perhaps the order of priority should be changed so that pensions already being paid should only be met in full up to a certain maximum amount, then workers and former members of the scheme who have not yet started receiving pensions (deferred members) should be provided with a particular minimum level of pension and only then would larger pension payments for retired pensioners and inflation-linked increases be met.

• Protect Directors' pensions last. If Directors' pensions were only protected after all other pension liabilities had been met, I think we would find that final salary schemes would be much better funded than they currently are.

• Legislate a maximum time for the scheme must be wound up - perhaps two years. It currently takes many years for most schemes to wind up and this lengthy delay is unreasonable.

  Fees paid to trustees and administrators in connection with the winding up process are all met from the scheme assets first and this means less available to pay pensions with.

  The longer schemes take to wind up, the higher these fees are likely to be. In addition, until the winding up process is complete, members not yet receiving a pension will not know how much they can expect to receive.

  
  

  Allow people to pay into more than one pension scheme at a time

  
  

  Dr Ros Altmann

• A central discontinuance fund backed by Government. This fund would allow pension schemes to keep investing the assets of the fund on an ongoing basis, rather than buying annuities and deferred annuities for members. This would need a Government guarantee, and is a less likely option.

• Allow people to pay into more than one pension scheme at a time, to allow them to build up pension rights outside their employer's scheme, if they want to.

  This is called 'full concurrency' and at the moment, not everyone is allowed to diversify the pension contributions like this. From last year, people earning under £30,000 can pay into an employer scheme and a stakeholder pension at the same time, but for other people, and before last year, this has not been possible.

Additional Solutions for schemes winding up when employer still solvent:

There are several policies required to address the problems of employers not being required to put in enough money to make up the total value of promised pensions when they wind up their scheme:

Employers should be required by law to properly consult their workforce




Dr Ros Altmann

• Employers should be required by law to properly consult their workforce about winding up the scheme and explain why and how they propose to change the pension arrangements. Pensions are 'deferred pay' and workers should have protection of these rights, in a similar way to protection of earned income. Employers cannot change other terms of work without proper consultation, so why should this not apply to pensions too?

• Require employers to give, say, 12 months notice of intention to wind up the scheme. This will give time for consultation to take place or for workers to make necessary alternative arrangements to replace any contributions and benefits lost when moving away from the defined benefit scheme.

  It should not be so easy for employers to just walk away from their pension promises. They have been able to do so easily, partly because most workers just do not understand pensions and have not always realised how much they will lose when the scheme winds up.

  Employers should be required to explain to their workforce exactly what the implications of moving away from the final salary scheme are.

• Change MFR funding calculation: Either the outdated assumptions of the MFR funding level calculation must be updated, or preferably the MFR should be abandoned and a requirement should be put in place that solvent employers should meet their liabilities properly.

  

  Employers should give financial advice
  

• Require employers to offer financial advice to members who are losing final salary or defined benefit promises. When an employer removes the final salary pension, the employee will be taking on additional risks and responsibilities. Normally, the money purchase scheme will cost the employer less than the final salary scheme, so the likely pension and other benefits for the workforce will be lower.

• Give members the option of not buying out their pensions with expensive deferred annuities, but transferring the sum due to them into a money purchase arrangement if they prefer. This would also need to be done with financial advice, but would mean a lower cost to the employer.

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