When I heard Frank Field comparing Sir Philip Green to the late Robert Maxwell, my heart dropped. This is not because of a judgement on either of these two individuals but because the result of the problems of the Mirror Group pensioners cast a chilling effect on the whole UK pensions industry.
The welter of regulation that followed the Maxwell crisis dealt a severe blow to already embattled pension schemes. By loading massive additional costs, it made providing generous pensions even less attractive to companies.
The conduct of pensions has three main interested stakeholders and one subsidiary one. The first is the interest of the pensioners themselves, both future and current who are interested in obtaining as higher pension as is affordable and that the promises in their pension scheme are honoured. The second is the current employees who are interested in the continuance of the company providing them with jobs and careers. Third, is the interest of the owners i.e. the shareholders who wish to obtain a reasonable return for their investment.
The subsidiary interest is the Government and taxpayers who may have to bail out the system or deal with future pensioner poverty as the guarantor of last resort.
These are of necessity competing interests and in a healthy environment, each interest is recognised but no interest is totally predominant. It is of no use for the pension scheme to drain the company of so much money that it cannot continue, nor is it good for the long term health that the employees and pensioners leave no return for the investors as any future source of capital will soon dry up.
The UK pensions system is an adversarial one where the pension scheme and the company appoint separate advisers on the valuation of the pension scheme and other important matters. Every three years there is a negotiation between the company and the pension scheme regarding the value of the pension and in a healthy environment there are robust discussions regarding not only the value but also any additional contributions required by the company to keep the pension scheme healthy.
The environment in the last few years has been extremely unhealthy for pensions; particularly, ones which offer a guaranteed amount to pensioners which is normally linked to their salary. A combination of low interest rates which reduce the income available to the pension scheme to pay out to the pensioners, low investment growth (the FTSE 100 is still lower than it was in December 1999) and the exponential growth in life expectancy have all contributed to a perfect storm. With the demands on pension schemes going up and the resources available coming down, like in the film, this does not have a happy ending.
At present, we are faced with two extremely unattractive alternatives, either the promises to pensioners cannot be met or that companies not only reduce their investments but potentially go under in trying to keep their pension promises.
The problems with Tata Steel have been hugely exacerbated and complicated by the yawning pension deficit. Pension deficits have cast a massive shadow over ex-nationalised businesses like BA and BT for many years. Should we be mortgaging our current companies’ future prospects in order to pay for past promises?
The reaction of many companies have been to shut down their salary linked pension schemes and transfer the risk to the employees by making them Defined Contribution. In addition, they have reduced the level of contributions into these plans. This means that the retiring cohort of pensioners in the next ten years (the last of the baby-boomers) will enjoy substantially higher pensions than those in succeeding generations.
These facts have made salary linked pension schemes hazardous to both the health of the sponsoring companies and in the long term to the nation itself. Perhaps one of the contributors to this crisis, the actuaries, have escaped rather lightly. The pension surpluses in the 1980s and early 1990s when the opposite conditions prevailed, high investment return, high interest rates and less movement on mortality led to companies taking pension holidays or even taking money out of pension schemes. After all, a surplus in the pension scheme can be construed as wasted capital. However, what the profession did not seem to do is to look at whether the circumstances which created surpluses in pension schemes could easily be reversed.
There is a view that if your investment manager does too well, you should look at sacking them because maybe they have taken higher risks than you would have wanted and there is almost an iron rule that factors which create large financial movements can always be reversed, which is indeed exactly what happened to pensions.
Actuarial calculations suffer from the failing of spurious accuracy, trying to put a defined financial figure on what, at best, are future forecasts being carried into the mists of time. For example, when carrying out a valuation, extending the life expectancy of the work force can cause a scheme which is in surplus to fall into a substantial deficit. It is actually the advances in medical science and the changing habits of the population which have a greater effect on pension liabilities. The effect of the smoking ban in public places in 2008 will have an effect on pension liabilities for the next 70 years, will this be counteracted by the increase in obesity? Nobody know. There is a discussion about the cohort of individuals born within the four-year period of our current Queen in 1926, who have lived substantially longer than those who were born before them. No one knows whether this is a temporary phenomenon caused by healthier eating during the War and will be reversed as more indulgent generations are counted. This is known as the short view. Or whether, the increase in life expectancy will remain and will grow, albeit at a slower basis, the medium view. Or whether the increase in life expectancy will be accelerated by new medical research, better diets and less smoking, the long view.
On these projections, billions of pounds of pension liabilities rest. As you can see, this is not an exact science and the danger is that one either puts too much in the pension scheme and damages the health and investment prospects of other companies or one puts in too little and the pension scheme goes bust.
It should be clear that the current scheme is unsustainable unless we have the re-emergence of the black death or some other such epidemic.
If the reaction to the BHS issue is yet more regulation, this could administer the coup de grace to many pension schemes. It should be noted that whilst the pension scheme is in surplus, there is no instrument which allows pension schemes to object to dividends being taken out. It is only when pension schemes are in deficit that they have substantial powers. But before rushing to give even further powers to pension trustees, one should pause before making them a second source of managerial decisions. You can build the most complex and regulatory system but it does depend on robust individuals as trustees of pension schemes asserting the interests of pensioners in conversation with the company which is representing the employees and the owners.
The system only works if there is independence and mutual respect. Ultimately the system depends on the quality of the individuals, whereas further regulation is akin to fighting a 21st century war with 20th century tools.
