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The great pensions debate: What’s the way forward? By Annie Hayes

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Pensions
The slow, lingering death of final salary pension schemes triggered by an ever-present pensions’ blackhole has concerned many workers and pundits alike; Annie Hayes, HR Zone Editor talked to the experts about the way forward and HR’s role in the pensions mix.


What’s the general state of pensions play in the UK?
In October 2004, Adair Turner, chair of the UK’s Pensions Commission shook the pensions’ world by revealing a shortfall of £57 billion a year. The demographics from which many occupational pension schemes were originally pinned were no longer viable.

As our population ages, the birth rate has slowed, resulting in a deficit of workers to sustain the funds needed and promised to support retired employees living for some ten, twenty or even thirty years more then was originally envisaged. Coupled with an underperforming stock market these factors have contributed to a bleak pension’s outlook.

Professor of Accounting at Lancaster University Management School, Ken Peasnell told me that a lot of the discussion surrounding pensions had ‘been wide of the target’ and that for many years the ‘deferred deals’ promised by some organisations were unrealistic and failed to take account of the changes and transformations most organisations are subject to in their lifetimes.

Do they work?
The defined benefits schemes that traditionally ruled the pensions roost worked on the premise that part of the pay given to a worker is deferred to a pension pot to be repaid in the form of an annuity of a seemingly unknown amount.

“Even the largest companies are subject to shocks and changes. Over a forty year horizon, we can be certain of some things. Ownership will change. Some companies will be taken over. Others will go bankrupt. All will go through periods of expansion and contraction, and employment opportunities will change accordingly,” viewed in this light says Peasnell the acceptance of a forty-year post-dated IOU looks like an extreme act of folly.

And Peasnell adds that the buffer of the final salary scheme, the cash contributions from employees and employers into the pension’s pot that could in the past be expected to exceed the payments to existing pensions is now drawing to a close.

“This would be of little consequence if the plan contributions had been invested in ways designed to match the time-and-risk profiles of the pension obligations, but that has not been the case. Only now are companies fully realising that a proper hedging of pension promises would require many schemes to invest more in bonds and less in equities, and that is going to be very expensive. In the future, companies with defined benefit schemes will have to carry what amounts to insurance, and the premiums are going to be very steep.”

“Only now are companies fully realising that a proper hedging of pension promises would require many schemes to invest more in bonds and less in equities, and that is going to be very expensive. In the future, companies with defined benefit schemes will have to carry what amounts to insurance, and the premiums are going to be very steep.”

Ken Peasnell, Professor of Accounting at Lancaster University Management School.

Many organisations have reacted by dumbing down their final salary pension promises and swapping to defined contribution plans, indeed for many new entrants the final salary perk is no longer offered. So what is the government doing to plug the shortfall?

This summer it responded to the recommendations made by Adair Turner in his second report for the Pensions Commission in which he suggested that key facets of the pensions system should be reformed including a complete reformation of the state pensions scheme, a hike in the age at which individuals can claim their pensions, and the introduction of a National Pension Savings Scheme.

The government has since confirmed that the age at which people will receive the basic state pension will rise to 66 between 2024 and 2026, to 67 between 2034 and 2036 and to 68 between 2044 and 2046. Simply put if we live longer we now need to work longer.

Pensions Minister, John Hutton has also confirmed that the government plans to go ahead with Lord Turner’s National Pensions Savings Scheme proposal.

The reaction to this news has been mixed. Peter Thomson, Director of the Future Work Forum at Henley Management College told me that pensions are not going far or fast enough and that the concept of a retirement age is outdated and ageist.

While many businesses are also concerned at the costs these reforms will present to them. Reacting to the news, David Frost, director general of the British Chambers of Commerce, added: “UK firms are facing intense pressures, both globally and domestically. Piling additional costs on to them will simply increase the cost of doing business in the UK and further undermine business’ ability to compete with rapidly developing economies such as China and India.”

So where does this leave employees? In a state of limbo, says Alan Francis an independent financial adviser.

“The future of final salary schemes is very uncertain due to ongoing costs, company wind ups, previous contribution holidays, under funding by employers and too low employee contributions.

“Too many individuals automatically join default managed funds without any understanding of the level of risk (medium to high with 80% equity content) because of lack of advice.”

In short there seems to be a total confusion. Whilst closing final salary schemes to new entrants goes part of the way to clear up the mess the way forward for the younger workforce is still unclear.

Has slashing final salary schemes damaged the psychological contract forever?
The decisions that organisations have to take regarding final salary pension schemes are driven predominantly by financial reasons. For a long time pensions have been seen as an integral part of the employment relationship so how does this impact upon the psychological contract between employer and employee.

“Traditionally, there was a cradle to grave concept of employment. You joined a firm looking for a lifelong career, you do a good job and the firm will look after you,” commented HR Consultant, Quentin Colborn.

But this doesn’t appear to be the case any longer and for many of the big firms including the BBC, Friends Provident, Harrods and the Co-op who have all axed their final salary schemes, their key retention tool together with a generous smattering of trust and loyalty has all but disappeared.

Charles Cotton, Reward Adviser for the Chartered Institute of Personnel and Development (CIPD) told me that the changes to the pension promise had indeed changed its hold over employees.

“Pensions used to be a retention tool they’re now an engagement tool.” And whilst for many years the pensions promise was a given, employees are now becoming more ‘aware’ of the issues.

Adrian Boulding, Legal and General’s Pensions Strategy Director believes that employees must play their part.

“I think workers were guilty of over-confidence in the 80’s and 90’s, and I don’t want to get back to that again. Today’s pensions are not ‘sign up and forget it’ type products. They require scheme members to take an active interest in both the quantity of contributions and where they are invested.”

“I think workers were guilty of over-confidence in the 80’s and 90’s, and I don’t want to get back to that again. Today’s pensions are not ‘sign up and forget it’ type products. They require scheme members to take an active interest in both the quantity of contributions and where they are invested.”

Adrian Boulding, Legal and General’s Pensions Strategy Director.

Lis Browning, Group Pensions Manager for Woolworths agrees. She believes that the psychological contract can be repaired as long as both parties agree that the responsibility is shared.

Are pensions the only option?
And many workers are starting to engage with the realities. There is no longer a job for life and a comfortable pension is not a given. Indeed for many types of workers particularly the young and those on minimum wages pensions are a problem only to be battled with once the brick and mortar challenge has been met and debts paid off.

Some HR Directors are starting to cotton onto this by addressing these issues before tackling the pension’s problem.

John Chilman, Group Pensions Director for First Group the largest bus and train provider in the UK with 74,000 staff, 44,000 of whom are based in the UK has given pensions a back seat to financial education and management.

Many of this large workforce are on take home weekly pay deals that fall below the national average. And for these workers becoming disenfranchised with the high street banks and getting into trouble with unscrupulous lenders is not out of the ordinary.

“We set up a Credit Union, a mutual. Members can borrow against their savings after a certain period reducing in many cases the cost of their borrowing to a fraction of their previous deals. We’ve saved five houses from being repossessed this year.”

And the rationale behind this explains Chilman is that for workers who are struggling with financial management their issues and concern impinge upon their general wellbeing and what they can bring to the company. By controlling this problem first they can then start to encourage their low earners to think about saving for the future.

Lessons can also be learnt from HSA, the healthcare group who decided to put houses before pensions. With over half, 59% of their staff under the age of 40 and many finding pensions a remote concept; the healthcare provider decided it was time to look at a reward scheme to help those looking to get across the threshold and into their first home. And whilst the tax and national insurance implications make it less attractive then a pension’s saving, the take up has been encouraging. Mark Day, HSA’s Human Resources Director tells me that as people reach their goal they can then transition out of the scheme and focus on their pension plans.

First Group and HSA are making an amends to a broken psychological contract, damaged by failing pension promises. By looking at the broader spectrum of issues that workers grapple with in the course of the employment cycle they are starting to engage employees again but this time without the pension’s carrot.

Chilman believes that first and foremost HR professionals should be fulfilling their obligation to educate workers financially rather then stipulating one course of action over another.

How can HR turn the pensions issue to their advantage?
Chilman and Day have shown that pensions can be addressed in context by addressing educational and primary concerns as a first port of call and moving workers onto thinking about pensions when they’re ready.

Cotton also believes that HR can work the pensions issue to their advantage but should be prepared for some hard-work: “If HR is going to carry any weight on this issue they have to become more knowledgeable and up-skill.”

“ If HR is going to carry any weight on this issue they have to become more knowledgeable and up-skill.”

Charles Cotton, Reward Adviser CIPD.

Becoming a genuine business partner is one route says Cotton who tells me that HR professionals must start contributing to pension’s decisions from the start rather then leaving it to FDs and MDs.

Boulding says that communication is the key: “What is important is the perceived value that an employee attaches to a pension scheme. A moderate pension scheme that is well presented will have a greater perceived value than an expensive scheme that is poorly perceived. So HR professionals and recruiters can use their communication skills to leverage competitive advantage out of the pension scheme, without it having to cost the sponsoring employer an arm and a leg.”

It is clear that the pension’s debate will continue for quite some time but HR professionals no longer have to fear that closing off their final salary schemes will turn would-be employees away as long as clear communication lines are in place, alternatives are set up and the immediate financial needs of the workforce are met.

As the demographic pyramid on which pensions were traditionally built changes beyond all recognition employers must wake up to the realities that promising a pension of x for forty years time is no longer viable. As employers traditionally move towards defined contribution schemes they find that their promise is very much more transparent, workable and equitable. HR Directors that can transition existing plans and focus on financial education will win out when it comes to engaging employees with the pension’s issue.

One Response

  1. Ongoing advice the key to Pensions success.
    One of the key points to consider is that despite the long term demise of final salary schemes, company money purchase pension schemes can still be a major success.

    On going advice for employees is the key to that success.

    Whilst there is a cost saving for the employer for moving from final salary to money purchase pension schemes, employees need support to understand and make important financial decisions for their future.

    How otherwise would employees be able to handle the decision of whether to contract in or out of the state second pension?

    And more importantly how would the employee be able to make the right investment decision for their circumstances?

    How would employees know that a default managed fund might contain 80% in shares and be totally unsuitable in terms of risk for an individual approaching retirement?

    How would the employee become informed about low risk funds such as property and bonds, against the risk of equity investments?

    So this is where advice comes into play, the HR professional and employer also needs to have a partnership arrangement with a pensions professional who is qualified to provide advice and is willing to be on site on a regular basis.

    By taking this approach money purchase schemes can provide a worthy replacement to final salary schemes and work profitably for both employees, employers and HR Professionals.

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