INVESTMENT BRIEF Radical thinking

The mounting cost of pensions is providing scope for previously unthinkable solutions, explains Anthony Hilton, Evening Standard

In 1980, it was estimated to cost £6 to deliver £1 of pension to an employee. By 2016, that cost had risen to £18. To put it another way, a defined benefit (DB) pension in 1980 cost 3.4% of the relevant member’s salary. By 2016, that cost had become 34% of salary.

These figures are provided in a paper published recently by JLT Employee Benefits, devoted not just to an analysis of the infamous pension black hole and what caused it, but also to making the case for some radical policy shifts, which it suggests could help to provide a long term and lasting solution to the issue.

The new thing is the willingness of government and the parties involved to put forward potential solutions which hitherto would have been considered totally off limits.
Anthony Hilton

Surge in cost

First, though, it provides an interesting breakdown of where the surge in cost has come from – and it is not quite as we have been led to expect. True, the collapse in interest rates and investment returns accounts for a 9.5% increase, but it is nevertheless the smallest of the three big cost components.

Next comes the increase in life expectancy. For example, a man of 65 in 1981 would have been told to expect a further 13 years, but by 2013 could look forward to another 18.4 years before death. The increase in life expectancy for women also increased sharply, though by less, moving from 16.9 years to 20.9 over the same period. People being expected to live longer has added 10.2% to expected costs.

The third factor is the least expected. The firm estimates that the biggest single component of cost increase, accounting for 10.6% extra of payroll, is the result of statutory increases to members’ benefits which were imposed on sponsoring employers by Parliament. In particular, these are rules which offer additional benefit guarantees, such as the revaluation of deferred pensions and various clauses which require the escalation of pensions in payment. It is an interesting observation that Parliament, in seeking to provide a better deal for some pensioners, in fact helped to precipitate the shrinking or complete removal of benefits for all.

Range of ideas

The most thought provoking part of the JLT paper is the way in which it senses a growing appetite for radical change. Issues which have been simmering in the background for years have been brought centre stage by the public exposure of problems at BHS and Tata Steel. However, the new thing in both was the willingness of government and the parties involved to put forward potential solutions which hitherto would have been considered totally off limits. JLT senses that the wind has shifted.

We have tried increased contributions, recovery plans, risk reduction and changes to investment strategy, but the problems are still very much with us and will crystallise as more and more schemes close. In addition, there is evidence of intergenerational unfairness, with firms scaling back contributions to defined contribution (DC) schemes while continuing to provide very much more to legacy DB schemes – £1,200 per DC member compared with £23,600 per DB member, according to the Intergenerational Foundation. It is possible that Brexit will free up the regulatory environment and provide scope for more creative solutions. It is time to be more radical.

JLT has a range of ideas. One of these would involve using a more realistic peg to inflation. Another is to change the bulk transfer regulations so that these might be allowed even in cases where there is a reduction in benefits. A third set of ideas is designed to make it easier for firms to simplify their benefit systems so that they can more easily merge into bigger more efficient units; if this happened on a large scale, it could save the pensions industry billions.

There is, of course, much more, including one suggestion which should perhaps be flagged: that the trustee role would be confined to making sure members can make informed decisions. They would not be able to prevent or unnecessarily frustrate any option.

Anthony Hilton has won many industry awards including European Business Writer of the Year, Wincott Business Journalist of the Year and the London Press Club's Business Writer of the Year. He joined Fleet Street in 1968 as a trainee on The Guardian. He was City Editor of The Times from 1981 to 1983 and City Editor of the Evening Standard from 1984 to 1989. He was then Managing Director of the Evening Standard for six years, before returning to the City Office as Financial Editor and economics leader writer for the paper. He has worked in television and radio, has written books on understanding finance and the City, and is a frequent conference and after dinner speaker and moderator on City and media matters. His interest in pensions was stimulated by a 19 year spell as a trustee of the various schemes in the Daily Mail Group. He currently serves a a member of the investment committee of the Harmsworth pension schemes.