The assets for all of the UK's corporate defined benefit (DB) pension funds will probably run out by around 2044, risk manager Cardano has warned.
There is going to be funding gap over the next 30 years or so, and in order to ensure that pensioners receive their benefits, assets will have to be sold to make up for the difference, which would then cause the assets to diminish over time.
Even though the problem will not grow as most DB schemes are closed, the problem is still huge and it will not go away, Cardano said.
Regarding defined contribution (DC) schemes, contrary to popular opinion they are not necessarily bad, as long as they are well designed, and Cardano argued that the UK has a chance to create a good system, as long as it learns the lessons from the Netherlands.
Stefan Lundbergh, Cardano Netherlands head of innovation, said: "The debate has become very infected – DB is good and DC is evil and bad, but there is a truth in between, because most DB schemes have deteriorated, they're not as good and stable as they used to be."
Just to make sure that there is enough money for DB schemes, around £370bn is needed over the next 10-15 years in extra deficit contributions.
Cardano said that according to the latest Office for National Statistics (ONS) figures, special deficit contributions were running at about £18bn p.a., but those are extreme highs as it is already and FTSE directors are not expecting them to continue over the next 10-15 years.
But also very crucially, equities need to outperform bonds by just 3.5% p.a. for the next six years, which Cardano said is plausible.
The system needs a "tremendous" amount of cash to be pumped in by companies, and there needs to be pretty optimistic assumptions about performance just to pay the pensions, Kerrin Rosenberg, CEO of Cardano UK, said.
"This is not a resilient system, it's a highly fragile system - it's a system that has no scope no scope to absorb disappointment or a shock. We need everything to work out perfectly and we need companies to take a huge proportion of their cash that they're generating and then stick it in the pensions systems, just to meet their promises," Rosenberg said.
Regarding the role of the Pension Protection Fund (PPF) Rosenberg said that although it works as a perfectly sensible mechanism as protection against the odd failure, it is not the solution to the problem – it is not equipped to deal with this problem on a large scale.
The debate in the UK is starting to move away from the 'good DB vs. bad DC' debate, and the UK is now beginning to have the right type of debate, he said.
If the UK wanted go down the collective defined contribution (CDC) schemes path, then it should learn from the mistakes in the Netherlands first, Lundbergh warned.
In Holland, there is now an awareness that the system is not great, especially since payments and transfers within the collective funds are not independently overseen.
But the UK would have a strong advantage if it decided to implement CDC as it would be starting from scratch, and Lundbergh said that it was better to deal build a good DC product now, than to deal with the problems later on.
The system would have to be fair for both young and old members and the trustees should focus on the members, rather than on serving the financial industry, Lundbergh added.
As part of the debate, the solution is restricted to the following options: pay more, work longer and receive less, Rosenberg said.
In any case, the solution to the problem has to be supported by all of the political parties, so that it is broadly accepted.
Rosenberg said: "In the UK there is sometimes a bit of cynicism of the Government tinkering with the pensions system. But looking back on it, a lot of those things were peripheral details.
"What we're discussing right now is really central and important, and we should not be distracted by the fact that there may have been in the some tinkering in the past."
He said that the initiative by the pensions minister is vital and that we should not allow a history of scepticism to prevent the UK from changing the rules.
He added that the debate in the UK should be taken very seriously, and that it must be widened in order to collectively figure out a solution.
First published 14.10.2013
monique_simpson@wilmington.co.uk
