WORK and Pensions Secretary, Amber Rudd, has put employers on notice that they must take their pension liabilities seriously. If they fail to do so, they risk severe fines and even imprisonment.
Government is right to be concerned as these liabilities have people’s lives attached: Government and regulators must be vigilant to ensure employers cannot just ignore their pension liabilities. The pension scheme ranks as an unsecured creditor, alongside all other unsecured creditors and recent insolvencies have suggested investors or shareholders can be prioritised over workers’ pensions.
Company directors need to recognise that their pension scheme is not just like any other unsecured creditor, these liabilities have people’s lives attached.
The cost of providing these pension promises has soared and most of these schemes are now closed – 88 per cent are no longer open to new members and 41 per cent are closed to all workers.
Amber Rudd wants to help protect pension promises: These final salary-type (Defined Benefit) schemes are the traditional, ‘gold standard’ company pensions. These schemes promise each member a specified amount of pension in retirement, with the employer shouldering the risks and costs. They were most prevalent in post-war Britain, with millions of workers relying on receiving these promised pensions in retirement as an important part of pensioners’ income.
Costs of these employer-‘guaranteed’ pension promises are much higher than expected: The costs of those pension promises soared due to increasing life expectancy, lower than-expected investment returns, abolition of some tax breaks and interest rates depressed by Bank of England policy. Forecast contribution requirements were far too low and many schemes ended up with huge deficits. Employers must make up the shortfalls.
If the scheme fails, workers’ pensions are reduced in the Pension Protection Fund (PPF): There have been several high-profile cases where employers have become insolvent, with inadequate resources to make up their scheme deficits. Before 2005, workers could lose their entire promised pension, but I am proud to have been able to help establish the PPF which offers protection for members now. This replaces most of the promised pension, but by no means all and the PPF results in workers losing some of their promised pension.
PPF is funded by other employer pension schemes who pay a collective insurance levy: The costs of PPF compensation are not paid by the Government, but by other pension schemes, who pay an annual risk-related levy to cover the risk of failure. When schemes fail, the PPF takes in the assets and, together with the money received from annual levies, it also makes investment returns on its assets. Companies who fail to fund their schemes adequately will increase the burden on other schemes. Put simply, more scheme failures increase the potential cost of the PPF levy.
As we approach the end-game for these pension schemes, employers may be tempted to find ways to avoid paying for past workers: As more schemes close, companies increasingly own legacy liabilities with no existing workers paying into the scheme. Yet they are on the hook to pay promised pensions for decades into the future. They have little or no business interest in carrying this ongoing liability, so they may naturally be tempted to find ways to offload the scheme.
Companies can only get rid of the scheme by buying expensive annuities – unless facing insolvency. Legally, companies can only walk away from their pension liabilities if they pay a huge sum to secure annuities for all members. This is often an unsupportable cost. If, however, the employer can prove it is about to fail, then there are mechanisms to negotiate with the Pensions Regulator and PPF to pay a lower amount and continue trading. Or, if the company actually enters insolvency, the PPF must pick up the cost of paying its reduced level of benefits to all members.
Trustees, not employers, are responsible for investment risks: This announcement suggests employers would be punished for their scheme taking unwarranted investment risks. However, it is the trustees of the schemes who decide on the asset allocation and, therefore, they are the ones who are accountable for managing both the risks and returns in an appropriate manner.
Baroness Ros Altmann is a Tory peer and former Pensions Minister.