This document was submitted to Rt Hon Andrew Smith MP Secretary of State for Work & Pensions by the Pensions Action Group on 9th September 2003.
* Legislation introduced by the last Tory Government is, in large measure, responsible for the loss of our pension rights. Flawed legislation, the negligence with which Governments have encouraged people into occupational schemes without risk warning and prohibition of diversification, mean members whose years of contributions have been confiscated to pay other people’s pensions have to be compensated.
* Ministers have said that deciding on compensation is difficult and asked for proposals as to how this can be done. This document provides suitable proposals.
* Compensation will cost nothing for at least 5 years, during which time, Ministers can plan to set aside funds (or use a source such as the ‘Unclaimed Assets’) to provide for the ongoing liabilities in future.
* Urgent action is needed to restore some confidence in pensions. No members of UK final salary schemes can feel completely safe at the present time.
[Post meeting explanatory comments on the above points: The 1995 Pensions Act was introduced with the best of intentions by John Major's government following the Maxwell Mirror Group pensions scandal. The act introduced the statutory order and the Minimum Funding Requirement (MFR). At the time the bill was drafted annuity rates were over 10% and the stock market was booming, so the MFR was just about adequate to meet its aim of protecting pension entitlements. Since then, annuity rates have fallen to something like 4% and the stock market has plummeted. Neither Tory or Labour governments or their advisors took account of these possibilities; indeed Gordon Brown has twice reduced the MFR behind the scenes and imposed a £5billion stealth tax on pension funds.
Both Tory and Labour governments were therefore negligent for not recognising what could happen, and for failing to put suitable precautions in place. The December 1998 Green Paper on pensions drew attention to the risk and mooted the idea of a Central Discontinuance Fund to cover the insolvency of an employer, but its comments were ignored.]
HOW THE GOVERNMENT CAN COMPENSATE:
* Start date:
The provisions of the 1995 Pensions Act came into force in 1997, and this is the date which should, therefore, be used as the start-date for compensation claims. It was after this that Government legislation prevented trustees of pension schemes from dividing up scheme assets on an equitable basis. In addition, the www.pensionstheft.org web-site has not been contacted by anyone whose scheme was wound up before this date. The vast majority of known wind-ups where members are losing their pensions are actually post 2000.
Instead of forcing schemes to buy index-linked annuities, allow scheme assets to be drawn down to pay pension commitments as they fall due.
Establish a central fund into which these scheme assets can be transferred, to reduce costs of administration and reduce ongoing investment management costs, by benefiting from economies of scale in managing a larger pool of assets. This central fund will also mean the high costs of wind up (often well over 5% of scheme assets) will be saved.
By using scheme assets to pay out pension liabilities on an ongoing basis, instead of buying index linked annuities, a typical scheme has sufficient funds to cover all costs for over 5 years. Compensation will, therefore, not cost anything for many years to come and this will give time to find or set aside funds for the purpose.
The attached paper is a brief description of how compensation will, if planned for properly, have zero cost short term and will not be too onerous over the longer term.
WHY THE GOVERNMENT MUST COMPENSATE
* Successive Governments actively encouraged people to join occupational pension schemes and promoted the benefits of these, without ever mentioning the risks. Scheme booklets were allowed to use words like ‘guaranteed’ and ‘promise’ and were not required to mention the risk that pensions might not be paid.
* Since Government promoted and encouraged occupational scheme membership (even allowing employers to make joining the company scheme a condition of employment) it was reasonable for members to assume that the benefits ‘promised’ were secure.
* Official advice was that occupational schemes were different from private pensions, which always had to warn that fund values would depend on investment performance and could not be relied upon to provide any particular level of pension. In practice, this is not true and many members would have been better off in personal pension schemes, if they had realised the risks.
* Furthermore, Inland Revenue rules prevented scheme members from having any other pension savings. This would not matter, if the pension contributions to employer schemes were secure, but they were not. Therefore, Government rules prevented diversification and forced members to put all retirement assets into a fund which depended on the continued existence of their employer. This is like investing all their retirement savings in the shares of their employer. If the employer failed, they could potentially lose all their pension – which is exactly what has happened to many.
* Pensions literature described employer schemes as ‘safe’ and led members to believe that their contributions were safe. After the Maxwell scandal, the Government introduced measures which led people to believe that pension rights were even more strongly protected than before. In fact, the opposite was the case.
* The 1995 Pensions Act (including MFR provisions) was introduced with the aim of protecting pensions. However, the MFR does not provide protection at all and the assumptions have been allowed to become so outdated that the funding of UK schemes is no longer adequate to provide ‘promised’ pensions.
* In practice, the law provides protection solely for those who have already retired and actually reduces protection for all other scheme members. By establishing an unfair statutory priority order, protection was removed from non-retired members, whose contributions and even any funds transferred in from other schemes, have been used to pay pensions to others, regardless of length of service or amount paid in.
* The 1995 Pensions Act was therefore badly flawed. The Government has recognised this and the proposed insurance scheme will protect non-retired scheme members on wind-up some time in the future. Anyone who has had their pension rights taken away from them by the flawed priority order is entitled to compensation for this loss of property.
* Several legal challenges have been started. If and when these succeed, the taxpayer will have to pay compensation anyway and will also have to meet the legal costs. It is simpler, cheaper and fairer to agree to pay now and would reflect well on New Labour.
* Compensating people who have been wronged by the pension system now will help to restore some measure of confidence in pensions. It is, otherwise, simply not safe for anyone to be encouraged to put money into their employer’s scheme.
Technical Details for Pension Wind-Up Compensation
The number of affected people is a major factor. Estimates range from 10,000 to 40,000. In this document a figure of 20,000 people has been used which gives upper and lower bounds of twice and half the calculated figures. Care must be taken to ensure the number only includes schemes which have been wound-up, not those which are simply closed to new employees or have changed their rules; for example using average rather than final salary.
It is assumed that each person is on an average salary of £22,000 and has an average service of 22 years. The average pension entitlement is thus
£22k x (22/60) = £8k pa.
People will, of course, have higher and lower entitlements dependant on salary and service, but the assumption of average figures is reasonable as both service and salary distribution curves are skewed towards the lower end (i.e. the median and the mode are both lower than the mean).
Deferred members also outnumber employees, and their lower entitlements will significantly reduce the average entitlement. The above figure is therefore a considerable overestimate.
To reduce costs and simplify management it is suggested that caps are placed on:
People below the age of thirty should have their payments returned. People below this age traditionally reclaim pension payments when they move jobs. They also have at least thirty years to make up their loss. Ageism starts at forty, so this is the absolute upper limit at which an age cap should be considered
People with service of less than, say, five years could also have their payments returned.
* Payable Pension
A cap should be placed on the maximum compensation pension. Possible amounts could be a specific figure (say £15k) or a multiple (say 0.8) of the national average salary. This would prevent the costs being distorted by senior management pensions. The proposed cap is approximately the pension that an employee on average salary would get with forty years service.
The cost reduction from these caps has been ignored in the calculations, so the figures below are again overestimates.
Compensation payments will need to be made for several years. With a lower cut-off age of 30 and a life expectancy of over 80 years the scheme would be active for something like fifty years. It is proposed to limit the scheme to post 1997 wind-ups. There will be no further joiners once the insurance scheme starts, so the compensation payable is finite and bounded.
All the costs in this discussion are therefore spread over the period of fifty years so the yearly cost is predictable and small.
Over this period the initial costs will be very small but will rise as more people join. After about ten years, mortality will start to affect the initial entrants. There will then be a period of maybe twenty years where the increase in cost of people entering the scheme is balanced by people leaving the scheme because of death. Over the final ten to twenty years the cost will fall to zero. The rate of fall will be compounded because late entrants will have less years of service, and hence be entitled to a lower pension. It would require a simple actuarial calculation to determine the true shape of the curve. Zero mortality has been assumed on the ASW Sheerness spreadsheet (which was attached to the document but is not reproduced here).
Method 1 Use of existing pension fund and direct payment
At present wound up pension funds are converted into annuities. The return on annuities is currently around 5%, for a fixed single life and lower still at around 3.2% for joint cover with indexing. This poor return is one of the major failings of the 1995 Pensions Act.
It is therefore proposed to use the existing pension funds to pay existing and new pensioners until the fund is exhausted. A well funded scheme can maintain this for at least ten years, a poorly funded scheme for about five years (figures are based on calculations by Dr Ros Altmann for ASW Sheerness). The government would therefore not have to pay a penny for at least five years. This gives time to plan the finance for the subsequent years.
As shown above, the average person would have a pension of £8k pa. This will be drawn for an average period of 20 years (age 65 to 85). With 20,000 people the average annual cost for the fifty years of the scheme would be
£8k x 20k x 20/50 = £64 million pa.
Note: The Sunday papers on 31st August 2003 spent a good deal of space discussing the announced ending of the postcode lottery on IVF. There appears to be a consensus of opinion that 20,000 couples will be treated annually at a cost of £15k each. The cost of this treatment is therefore about £300 million pa; nearly five times the sum required to compensate people who have lost their pensions. IVF treatment will also be ongoing and is not bounded.
Method 2 Annuity purchase
The poor annuity rates make this an unattractive approach, but it is included for illustrative purposes. This method demonstrates the problems created by the 1995 Pensions Act
To produce an income of £8k pa with joint life and indexing requires a sum of
£8k / 0.032 = £250k.
This sum will be required for each person over a period of thirty five years (the time taken for the 30 year olds to reach 65)
The average annual expenditure to provide for 20,000 people is therefore:
£250k x 20k / 35 = £143 million pa
If compensation is not paid, a majority of the affected people will be entitled to state benefits. The cost of these benefits should therefore be calculated and deducted from the above costs to give the true net cost of compensation. The above figures are therefore, again, overestimates.
The use of unclaimed assets could provide several billion pounds and may actually provide sufficient funds to cover Method 1 entirely. The first five years or so could be covered by the funds themselves and the remaining period by the unclaimed assets at zero cost to the government.
Dr Ros Altmann
5th September 2003