Retirement Benefits, the next negative(FRS17 vs SSAP24)

The pensions watchdog is helping to turn a national problem into a crisis
By John Redwood




A NEW fear is stalking the UK corporate world. Many companies have pension funds with large deficits. Even though the investments in those funds are often now performing well, every time that directors and trustees look the deficit has gone up. Some large companies’ balance sheets are about to be swamped by the new requirement to include the pension fund shortfall. The Pensions Regulator has to sit in judgment on many corporate transactions, telling companies how much they need to pay into the fund from the proceeds of selling a business. The pension fund can now be a deal-breaker, an impediment to refinancing a business.
Less than ten years ago we could boast that the UK had the best protection for old age in the whole of Europe, perhaps the best in the world. The UK had far more pension promises covered by well- invested funds. Year after year, the funds went up in value. Some were so strong that companies could stop making payments. Many gave more generous benefits to pensioners.



From 2000 onwards, things changed. Some blame the Chancellor for his decision to tax the income on shares held in UK pension funds. That took billions out of the funds each year, and helped the downward decline in share values. If tax is now running at £5 billion on shares in pension funds, and you value company income at 15 times earnings, that implies a £75 billion loss of capital value.

Friends of the Chancellor blame world markets, pointing out that other equity markets fell, as well as London, although usually not as far. Both sides agree that the loss on investments, coupled with the tax on the income, left many funds in deficit.

If companies agreed to put in more money to pay the extra tax bill, and if actuaries agreed to let trustees wait for a recovery in share values to put right the capital loss, we might, over the medium term, see the problem vanish. Instead, new developments are turning a problem into a crisis.

The advent of the Pensions Regulator seems to make actuaries much more cautious in the assumptions that they make. They have decided that people will live considerably longer. If you add years of life expectancy to the typical fund member, it makes a big difference to how much money you need to pay the pensions.

They have also decided to assume that funds will earn much less from their investments in the future than they assumed in the past — less than many funds have earned in the past. Actuaries start from the long-term rate of interest offered on government debt. This is currently low, so it inspires pessimism about general investment returns, even if you are invested in totally different assets from long bonds.

Many companies have responded by shutting their funds to new members. It is a pity that a new generation is being denied the good pension protection that their parents took for granted. Actuaries and investment advisers often advise closed funds to put more of their investment into “safe” government bonds. The same actuaries then assume a lower rate of future investment returns, because bonds usually give lower returns than shares. The deficit goes up again! The Pensions Regulator is replacing the Minimum Funding Requirement, which all funds have been able to meet, with a new fund-specific figure that is likely to require considerably more money be put into the typical fund.

Any company with a deficit on its fund will have to account for it as if it were a debt to a bank or other third party. The difference is that the pensions deficit is an estimate of very big figures over a very long time. No one will know how accurate it is for the next 20 or 30 years, and it may fluctuate wildly, depending on stock market movements and interest-rate changes. It may turn out to be a real debt for the company, or the debt may disappear if investment returns stay high.

Just to make it even more costly for companies, each fund will have to pay a levy into the Pension Protection Fund. A company will have to pay a proportionately bigger levy if it has a weak balance sheet, and if its own fund has a deficit. It is a vicious circle — the deficit may dominate the company balance sheet as well, causing a double hit in the form of a higher levy.

In some difficult cases, the combined impact of higher contributions into the pension scheme and the new levy could bankrupt the company concerned, leaving the pensioners and future pensioners far worse off than if the company had continued paying something into the fund. Often the best guarantee of a future pension comes from the continuing financial health of the sponsor company.

Can the crisis be averted? Yes it can. The Regulator should allow a longer time for adjustments to be made, and should ask actuaries to vary their assumptions more gently over time, instead of rushing to make big changes all in one go. Now is a bad time to be valuing a fund, especially on a break-up basis; long bond rates are very low by historical standards. They determine the outcome and are dictating very bad news for companies and trustees. Now is not a good time for the regulatory system to seek to crystallise many of these liabilities.

Advisers directing people into too many UK bonds at low rates of interest may not be helping, when assets with income and capital growth potential are more likely to sort the problem out. Forcing UK business to spend a very large proportion of its free cashflow and asset sales proceeds on pension deficits is no way to create a strong UK corporate sector. Without a vibrant corporate sector, all pension funds will be the weaker.


The author is Shadow Secretary of State for Deregulation