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Defined Benefits Pensions – Death by 1000 cuts

Defined Benefits Pensions – Death by 1000 cuts

The raucous noise you keep hearing in the background is the wailing of many in the pension world as they decry the attempt by the Treasury to remove the DB (Defined Benefit) albatross around the Tata Steel’s neck by restricting the pension’s annual increase to the CPI (Consumer Price Index) rather than the higher RPI (Retail Price Index) measure currently used.  According to industry experts, this move undermines the whole basis of defined pensions by reducing the entitlement of the pensioners - for the first time ever - and is likely to be followed by many other companies seeking to get the pension liabilities on their balance sheet under control.

The Business Secretary, Sajid Javid, speaking in Parliament said that he was wary of setting a precedent but was setting up a consultation as the owners of Tata Steel were adamant that the pension issue was a key blocking factor in attempts to sell off the plants as going concerns, and thereby saving many of the jobs currently under threat.

The problem with the Government’s approach is not that other firms could follow Tata; it is that so many other firms are so desperate to follow it.  The reality, which the pension industry is doing its damnedest to ignore, is that the whole basis of the promise under DB schemes is flawed.  These schemes should never have existed, the companies providing them were taking on liabilities that they were in no position to guarantee, the actuarial formulae for estimating the required contributions were just estimates i.e. clever guesses, and no amount of clever tinkering will remove the burden from the sponsoring firms.

The system is a patronising one, which for its success depends on the ability and willingness of the patron to actually pay up for the client.  This was easy in the days of growing firms, when pension contributions were constantly increasing and longevity was much lower.  Now that people are living longer and firms are much smaller in terms of the workforce required, the return on the investments is no longer sufficient to cover the gap, and the vast majority of pension schemes have severe and widening deficits.  Firms are being crippled by liabilities that they would never have taken on if they had known how changes in longevity would increase them.  This whole issue is going to weigh down the UK industry until some solution is found to end this ever-increasing pension liability and allow firms to free up their profits for investment.

No doubt, moving to CPI reduces the liability but it reduces it from a huge unknown to a slightly smaller unknown – still not the kind of change that’s going to radically change the pension landscape.  The bottom line is that the shareholders should not be carrying this liability.  Contributing to pensions as part of compensation packages is fine, but carrying the longevity and the investment risk made little enough sense in the era of jobs for life and makes absolutely none in an era where the average person has 11 jobs across their career.

The Government’s proposal is that it doesn’t go far enough.  What’s needed is a move from DB to DC (Defined Contribution) pensions.  This will move the risk of managing their money to the individual themselves, where it should be.  And the quicker this move is replicated in the public sector to get taxpayers off the hook too, the better.

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