News

Pensions Watch - June 2010

Work until you drop?

As Nicolas Sarkozy battles to raise the French state retirement age (SRA) from 60 to 62, Pensions Minister, Steve Webb and Work and Pensions Secretary, Iain Duncan-Smith, have signalled to the British electorate that a move in the UK SRA for men from 65 to 66 is to be brought forward from 2024 to 2016.  Britain joins six other Organisation for Economic Cooperation and Development (OECD) countries in seeking to raise the SRA above 65 – a move that would boost UK GDP by £13bn per annum.  In all likelihood the SRA for women will be equalised to that of men in 2020, with the prospect of a progressive move to 70 for all by 2046.  As noted in the May edition of Pensions Watch, there is even talk of linking the SRA to life expectancy.  Lord Turner, the architect of the 2005 Pensions Commissions Report, which recommended a timetable of moving to a SRA of 68 by 2046, is supportive of the new proposals.  In addition, the default age of 65, at which employers have the right to terminate an employee’s contract, is likely to be phased out from 2011.

Interestingly, despite the proposed changes to the SRA being described by one of the unions as a “work until you drop” policy, the National Childhood Development Study, which is tracking the lives of 10,000 people born in one week in 1958, found that almost nine out of 10 people in their early 50s are considering working past state retirement age either as a matter of financial necessity or to secure a higher standard of living.  Indeed, 70 per cent of those surveyed expressed concern about whether they would have enough money to see them through their retirement.  Currently, men over 65 and women over 60 comprise 12 per cent of the UK’s near-30m strong workforce, compared to 6 per cent a decade ago.

Making ends meet

Pity the coalition government as it contemplates the unenviable task of ironing out the inequalities between pension provision in the public and private sectors and between those at the upper and lower end of the earnings spectrum, with “tough but fair” fiscal consolidation the end game.  After all, putting public sector pensions on a more sustainable footing and cutting the cost of tax relief on pension contributions in a system markedly skewed towards high earners, without accelerating the closure of private sector defined benefit (DB) schemes, are decisions that the previous administration failed to tackle head on.

First, public sector pensions.  As the debate over the potential major reforms to be made to “gold plated” public sector pensions continues to rage, so the numbers surrounding their costs and benefits continue to be contested.  Whilst the trade union Unison quite correctly points out that the average payout from the Local Government Pension Scheme (LGPS) is around £4,000 per annum, that paid from the four main “unfunded” public sector schemes, those principally funded by the taxpayer and which, in the main, continue to be tied to employees’ final salaries and are index-linked, is considerably more.  According to the National Audit Office (NAO), this ranges from £6,000 for the average Civil Servant to £9,400 for the average Teacher.  However, these figures are distorted by the sums payable to part-timers, temporary staff and early leavers and mask the sums paid to the schemes’ top earners.  For instance, the top 10 per cent of pension payouts from the London LGPS are in excess of £16,000 per annum, while the top 15 per cent paid from the mighty NHS scheme exceed £40,000 a year.  As to the aggregate cost of provision, in the March edition of Pensions Watch we noted that in 2008-09 the taxpayer contributed £14.9bn of the £19.3bn paid out from unfunded public pension schemes.  To put this into perspective, at about 1.7 per cent of GDP, this item of public spending alone exceeds the 2015-16 target for government borrowing set out in this month’s Budget at 1.1 per cent of GDP.  Ironically, the task of conducting a fundamental review of public sector pension provision falls to John Hutton, the former Labour Secretary for Work and Pensions, who will chair the Independent Public Service Pensions Commission, which will make its recommendations to George Osborne ahead of his autumn spending review.

Meanwhile, inequalities in the distribution of and the sheer cost of tax relief granted on pension contributions are another area targeted for fiscal consolidation.  According to the Treasury, one third of total pension tax relief is paid to those earning at least £100,000 per annum, with those earning upwards of £150,000 taking nearly one quarter of the total.  Much of this near doubling of the long run share of tax relief claimed by these high earners has been experienced since the A-Day reforms of April 2006, which saw the ceiling on annual pension contributions raised from 15 per cent of pay to £255,000 today.   As George Osborne faces pressure from the pensions industry to resist implementing the changes announced by Alistair Darling in the 2009 Budget, namely to limit relief on pension contributions made by those earning £130,000 or more from April 2011, the Treasury is thought to be considering a £30,000 to £45,000 limit to annual pension contributions that can attract the top rate of tax relief.  Whilst this would save the Treasury about £3.5bn per annum in tax relief, separately the LibDems had hoped for tax relief to be restricted to the basic rate of tax as this would have saved the Treasury £5.5bn per annum.   

The other 2012 event

The coalition double act of Messrs Webb and Duncan Smith have also launched a three month review of the costs and benefits to individuals, employers and the Treasury of auto-enrolment into Nest accounts, which is due to be implemented from 2012.   The review, due on September 27th, will consider the age and earnings threshold at which auto-enrolment should apply and the size of firm that should fall within the initiative.  It is well know that Steve Webb is a fervent supporter of a Citizens’ Pension, the mainstay of which is a higher basic state pension, but is not so keen on Nest accounts. 

That sinking feeling
The aggregate funding position of those 7,300 UK private sector DB pension schemes, covered by the industry funded Pension Protection Fund’s (PPF) safety net, recorded a £41.5bn deficit at the end of May, compared to a £2.2bn deficit in April, as falling equity markets and falling bond yields caused scheme assets and liabilities to move in opposite directions.

Come fly with me

With a market value of £2.5bn and a combined deficit for its two DB pension schemes, comprising 100,000 members, of £3.7bn, British Airways, once the “world’s favourite airline”, soon became known as the pension scheme with the airline attached.  However, BA now having agreed a 16 year recovery plan with the schemes’ trustees over funding these deficits, has cleared the way for its much vaulted merger with the Spanish Airline Iberia and the formation of a new larger parent company - the International Airlines Group.  BA has agreed with the trustee not to make any dividend payments to shareholders at least until the next dual scheme valuation in 2012, to increase its £330m annual contribution to the schemes by 3 per cent per annum from 2011 and add to these if its current cash balance of £1.7bn exceeds £1.8bn.  Although subject to approval from The Pensions Regulator (TPR), who would no doubt have much preferred a shorter recovery period, TPR is rumoured to be positive about the deal.

One size doesn’t fit all

The OECD in a recent working paper on default investment strategies for Defined Contribution (DC) pension schemes, found that no one default strategy works in all market conditions, strategies with equity allocations of under 10% or over 80% were the least efficient and life cycle strategies that swiftly de-risked into bonds in the decade before retirement outperformed those that didn’t.  Separately, according to Clear Path Analysis, whilst 40% of UK pension schemes invest in diversified growth funds (DGFs), which are increasingly becoming the default fund of choice for DC pension schemes, 84% of the 32 pension schemes surveyed suggested that they were not fully confident that DGFs would protect investments in a “stressed market”, despite 66% of respondents stating that they themselves invested in the funds.

Not a vuvuzela in sight

Former Boomtown Rats front man, Sir Bob Geldof, has added his voice to a number of fund manager calls to UK pension funds to consider investing in the African continent.  Forthright as ever, Sir Bob, who has campaigned on Africa since the mid-1980s, argues that UK pension funds are “behind the curve” and are missing out on the “last great investment opportunity.” As he described it, the continent’s “fundamentals [are] staring [them] in the face.”  These include 200m new consumers to emerge over the next five years, 25% of the world’s available arable land to address looming global food shortages and £24tn of mineral deposits.  Outside of investing in FTSE 100 South African mining stocks, only the Royal County of Berkshire Pension Fund is believed to have a made a strategic investment to the continent via a fund which invests in companies domiciled in Botswana, Ghana, Namibia, Nigeria and Tunisia.

And finally…

Will you still need me, will you still feed me, when I’m 64 ...or 80, or 95 for that matter?

We started this month’s Pensions Watch with proposals to raise the state retirement age (SRA), so that’s how we’ll finish.  Many of you will know that the first old age pension was introduced by Otto von Bismarck in the 1880s.  This pension was payable at age 65 at a time when German life expectancy was 35.6 years for men and 38.4 years for women.  According to the think-tank the Geneva Association, given the exponential improvements in longevity since then, the German SRA should have increased to 95 today.  Similarly, the UK state retirement age of 65 set in 1940 was when post retirement life expectancy for men was around seven years.  This has since trebled, suggesting that the state retirement age should have risen to around age 80 today.  Meanwhile in France, it’s interesting to note that even if Mr Sarkozy manages to win the day against fierce public opposition, a state pension age of 62 would still be one of the lowest in Europe, even though the French have one of the world’s highest life expectancies.

10/0767/310711

Download this article as a PDF

Pensions Watch - June 10.pdf Download »