04 March 2005
What are you going to do when you hit retirement age? Jump on to the first cruise ship round the world, or sit at home by your single-bar electric heater and count the pennies?
A few years ago, this would have been a mildly amusing question for most middle-class professionals working for well-established firms. Not any more. Since the collapse of the equity market in the late 1990s, pensions have ceased to be anything to joke about.
"We're now at the end of a golden era of pensions," explains Robin Ellison, head of strategic development, pensions, at law firm Pinsent Masons - and, as incoming chairman of the National Association of Pension Funds, he should know. "People can see their parents being extremely well off in retirement and may assume that it will be the same for them." If you are one of the people who thinks this, then you should speak to your financial adviser, but the chances are that it won't be good news.
Ellison believes it is vital to get this message across, not to induce mass panic, but to ensure that everyone is thinking seriously about their future. The statistics are not reassuring. While many companies are facing up to massive pensions deficits - and we're talking hundreds of millions of pounds, not the odd fiver -- a disturbing number of employees are sticking their heads in the sand. It may be that they have lost faith in pensions after the collapse of firms such as Equitable Life, or that they are hoping that alternative investments in, for example, property will keep them in their old age, but the unpalatable facts are that the number of people under 30 currently investing in a pension has dropped, companies are continuing to close final salary pension schemes and life expectancy is rising. You do the maths.
One major problem is that no one (and that includes finance directors, pensions advisers and government ministers) really understands pensions. This is not because the information is not available. The UK is drowning in pensions legislation. "Other countries have an average of 25 pages of pension legislation," Ellison points out. "The UK has 8,500." It's just too complicated for mere mortals to comprehend.
This year will see several developments in the pensions arena, and Ellison is optimistic that they will help. In April a new regulator comes on board, in September the European pensions directive comes into force, the Turner report into pensions is due out in October and tax changes in April 2006 may open up new opportunities for companies to create alternative packages for their staff. "The good thing is that the situation is now so horribly awful that everyone is of the opinion that something has to be done," Ellison explains.
Financial directors, pension fund trustees and investors will be hoping that this optimism is not misplaced. "The key problem is that the pensions industry and, indeed, the government, in trying to increase pensions security, have made a dull, specialist area incomprehensible to the layman. It is easier to complete an Isa than to start any form of pension - why?" asks Tor Farquhar, financial director at Alfred McAlpine.
Of course, companies with substantial pension schemes cannot afford to wait to see what the future holds. The accounting standard FRS17 fundamentally changed the view of the value of corporate pension schemes and investors were not impressed by the sudden appearance of "black holes" in the company accounts. While the new standard did not actually change the performance of the firm, it did highlight potential future liabilities in a way that was sometimes shocking.
Global HR consultancy Hewitt calculated that the combined pension deficit of the FTSE100 in 2004 was £60 billion according to FRS17. "We assessed that to wipe this out overnight, we'd need a 30 per cent equity surge relative to bond values," says Raj Mody, pension strategy consultant at Hewitt. "But, of course, FRS17 is just a line in the sand. If you look at what it would cost firms to walk away from their pension fund - the buy-out deficit - we reckon it would cost another £100 billion on top of that."
Most responsible companies have realised that praying for this kind of equity rise is not an option. Most have responded in two ways. First they consider how to reduce their existing deficit and then they look to reduce liabilities still accruing. This can be bad news for staff.
The most common response has been to close final salary schemes to new entrants and to replace them with defined contribution schemes. Whereas under the first system the company takes the risk of a drop in fund values, employees in defined contribution schemes share the risk since their pension depends on the value of the fund when they retire. In addition, many companies are increasing the scheme retirement age and cutting the percentage of salary they contribute to it. Many are also looking closely at their investments and deciding whether to remain in equities or to play it safe with bonds. These measures limit companies' exposure to future risk, but the only way in which most can reduce their existing liabilities is to pay lump sums into their deficits. The lucky ones do this from reserves. Those that cannot afford this must use alternative methods, such as loans or bond issues.
Facilities management firms are no exception to the general rule. John Laing recently warned investors that its pension deficit was likely to rise in the near future, although it went on to explain how it intended to deal with the problem in the long term. The company closed its final salary scheme to new entrants two years ago and introduced a defined contributions scheme for new staff.
Adrian Ewer, the firm's financial director, explains that John Laing has particular issues because of its history. "We have a very large scheme with a relatively small number of current members because we used to be a construction firm, but sold that business in 2001," he says. The company has about 9,500 people in its scheme, but only about 100 employees are active. About 6,500 are deferred, meaning that they now work for another firm, but will be able to claim their final salary pension from John Laing when they retire.
"This means our scheme is very mature. The liabilities are well established and the only thing that is likely to affect them in future is inflation and mortality rates," Ewer says. "At the last calculation in December 2003 our deficit was about £90 million, but we expect this to rise in the next assessment because of inflation and because, under the new international accounting standards we have to calculate the net present value of our liabilities using corporate bond yields and these can move."
The advantage of a mature scheme is that the firm can make detailed plans about how to rid itself of the deficit in the long term. At the moment its pension is invested equally between equities and non-equities (including bonds). "We aim to move wholly out of equities by the time our last member retires in about 25 years time," Ewer explains. "Our strategy is to fully fund the deficit over a period of about 20 years and we're putting money aside for this, we're not intending to borrow."
This scheme, however, only covers some of John Laing's staff. Like other facilities management firms, the company has gained staff through mergers and acquisitions, along with their pension provisions. It can therefore be hard to identify the true situation in such diverse companies. Alfred McAlpine, for example, insists that it cannot give a general view of its pension because it has too many schemes to incorporate.
John Laing is also not alone in expecting its deficit to increase in the near future. Rentokil Initial paid £6.8 million into its pension scheme in March 2004 and intends to pay a further £10 million in March 2005. "Contributions thereafter will be determined by the outcome of the March 2005 triennial revaluation which, while not quantifiable at this stage, is likely to show a significant increase," it warned in its interim results for the half year to 30 June 2004.
Land Securities, meanwhile, closed its non-contributory final salary scheme to new entrants and introduced a contributory money purchase scheme for all new administrative and senior property-based employees on 1 January 1999. It has seen its pension deficit rise from £12 million on 6 April 2001 to £22 million on
1 July 2003. It blames this on "a sharp fall in equity markets over that period (a fall of 20 per cent) and an increase in life expectancy that has been revealed by recent industry investigations", according to its statement in March 2004.
As a result Land Securities paid a one-off cash contribution of £7.5 million in March 2003 together with the first payment of an annual contribution of £1.5 million recommended by its actuary. The second £1.5 million contribution was made in March 2004. The next valuation of its pension fund will take place by 1 July 2006. Land Securities also has legacy schemes from acquisitions that are not included in these figures.
It seems therefore that facilities management firms are following the trends highlighted in a 2004 survey from the Chartered Institute of Personnel and Development, which showed that most firms are offering new recruits defined contribution schemes rather than defined benefit schemes. They are also being responsible about funding their deficits in the long term and expect staff to take some responsibility for future risk.
"I believe that it is a requirement for companies to contribute towards employees funding their retirement through their working life, the government's job to provide the safety net, and some guidance about what employees should be saving, and the employees' responsibility to decide what risks to take, whether over funding or investment," says Farquhar. It seems that if you want to enjoy your Saga holidays you had better start thinking about it now. Nobody else is going to.
Ruth Prickett is editor of Financial Management, the magazine for the Chartered Institute of Management Accountants