Pension Funds Online

Reasons to be Cheerful?

The depths of the worst recession in living memory might not seem a good time to be upbeat about the future of pensions. It may feel like we are already living in Wonderland, where we can imagine several things that were previously impossible - and all before breakfast - but there can still be solutions.

First, some background – just how bad has it been? Actually pretty bad:

• Equities - the 2nd worst fall in a calendar year in the UK since 1974
• The 3rd worst ‘peak to trough’ decline in equities, after 1974 and the dotcom crash
• Property – the largest fall in property returns
• Sterling – the 25% fall in sterling exceeds the 17% fall at the time of ejection from the ERM in 1992
• Gilts – the 1.4% fall in yields in calendar 2009 is not that big (1982,1992,1993,1998 saw larger falls)

If you add in interest rates at their lowest for over 300 years, you can certainly see that we are experiencing the ancient Chinese curse "may you live in interesting times". Interesting maybe – but surely it's all one way traffic for pension schemes? We cannot open the papers – especially the pensions press – without seeing an article called "the death of final salary schemes". Just how many nails have been banged in the coffin of defined benefit pension plans? Our own analysis, published recently, focused on aspects other than closure to existing members. Certainly closure was on the cards - considered in 52% of cases. But a number of other potential changes were mooted – reduced accrual rates (35%), increased member contributions (42%), hybrid plan designs (32%), caps on pensionable pay increases (28%) and so forth. A sizeable proportion of the schemes surveyed were doing all they could to avoid the final step of closure to existing members. They value final salary pensions and recognise this is a step that once taken is unlikely to be reversed. So can we expect support from policy makers and government help?

This is where I offer my ideas for being cheerful. We have seen how governments around the world are prepared to take unprecedented steps to ensure the continuation of economic activity. So what can we expect for pensions?

Perhaps the easiest move would be for the Treasury – specifically the Debt Management Office – to review their approach to issuing long-dated index linked bonds. This stands out as a win-win solution: the government gets cheap long term finance, while pension funds are no longer plagued by the supply/demand imbalance that distorts valuations of pension liabilities in accounts and funding plans – and also in the prices quoted by buyout firms to remove liabilities.

And what about the increasing pressures faced by trustees? Are we simply asking too much? There seems little doubt that many trustees would be relieved to shed some onerous investment decisions. The speed at which markets move and the complexity of solutions are challenging the most able professionals, let alone trustees, most of whom have other significant responsibilities.

We may need more radical solutions. We have heard about bail-outs for the banks and the car manufacturers – how about for pension funds? Why not separate pensions' past liabilities from the banks before returning them to the private sector? Leave them behind in a government guaranteed fund; use this improved covenant to take a very long term view and pile the assets into equities and other return seeking assets. Long term costs would be cut, no explicit bail-out is needed and the government could pick up any upside in return for its guarantee.

In return, the benefits for existing members could be equalised on new uniform DC terms. Harsh, but the price one might have to pay for government backing. Executives might even have to take their (DC) pension in the form of company stock, to be held until retirement to ensure they continue to have a long term view.

And finally, we have an ever growing pensions disparity between the public and private sectors, though this does need to be viewed more broadly by assessing total remuneration. I would encourage some radical thinking here – moving public sector schemes to the "Collective DC" basis that we have been exploring with the DWP. This could have the magical advantage of a benefit structure that looks and feels like DB to public sector workers – but which behaves like a DC scheme for the tax payer - and does not impose unpaid and unwarranted taxes on future generations to pay for current promises.

All in all, I can think of many reasons to be cheerful – there could be a silver lining to the clouds above us.

www.hewitt.com

Michael Clare is Head of the Hewitt UK Retirement Practice, a position he has held since July 2007. Prior to that, Michael has held various management positions within Hewitt, including leading the Birmingham and Epsom offices. Michael has been advising Trustees and Employers on their pension arrangements for over 20 years. He qualified as an Actuary in 1993 having graduated from Birmingham University in 1987. Michael currently advises a number of Trustee clients, many of whom are in the Automotive Sector. Michael is married with two children. In his spare time his hobbies include golf, running and supporting Liverpool FC.