Pension cutbacks as shortfalls loom
A rash of British companies have imposed further cutbacks on staff pensions in the wake of plunging investment markets and mounting fears of huge shortfalls.
This week supermarket chain Morrison and high street bank Barclays both closed the door on their final salary pensions to new contributions from existing members, while BP closed its scheme to new employees. The moves mark a significant escalation in the closure of such pension schemes and experts predict more will follow.
Independent pensions expert Ros Altmann says the costs of running final salary schemes are leaving boards with little choice.
“Given the enormous costs involved, the question for most boards is not why should they close their scheme, but why should they keep it open," she explains. “A final salary pension adds well over 20% to payroll costs and, given the large deficits in most schemes, the costs could well rise to over 40% in coming years. But it is not just the level of cost that is the problem, it is also the uncertainty of that cost.”
Just five years ago, around 40% of companies still offered final salary pensions to new employees. Altmann points out that there are now just four FTSE 100 firms who do so - Shell, Tesco, Cadbury and Diageo.
Businesses cut back
Barclays has applied the brakes to its pension scheme to existing members as well as new staff, claiming that it was forced to take action due to the rising costs involved in providing guaranteed pensions to 18,000 employees.
Members of the existing scheme will see their pension rights frozen and moved into cheaper arrangements. The decision will affect chief executive John Varley, who is expected to follow the example of other directors and set up his own retirement plan.
The bank says the move is “in the best interests of all Barclays employees and shareholders”.
Meanwhile, the 10,000 staff in Morrison’s retirement scheme will receive a pension based on an average salary for their entire career rather than the amount they are paid for the final year of employment. The supermarket giant has already shut its scheme to new members.
Morrison says that it will “move all future benefit accrual onto a career average basis, such that it will grow in line with inflation rather than being linked to final salary”.
BP will close its final salary scheme to new recruits; it blames difficulties on “managing future costs and risks”.
Instead, employees joining after 2010 will be offered a money purchase scheme in which their pension will be linked to the performance of the pension fund rather than to the employee's salary level. BP estimates the move will save it around $120 million a year within 10 years.
Altmann warns that there is worse to come for private sector workers: “If anyone was previously still in doubt as to whether final salary schemes had a viable future, the latest announcements should have removed the uncertainty.
“The demise of these top-quality, traditional pension schemes is a serious issue for the future, as more and more employees face uncertainty in retirement, with inadequate state pensions, no employer to rely on and an annuity market that they do not understand."
She adds that forthcoming pension fund valuation statements, taken at the end of March, are likely to make for very grim reading due to very low asset prices and artificially depressed gilt yields as a result of the Bank of England’s quantitative easing programme.
“The huge deficits to be announced in coming months will lead to a torrent of new closures, as private sector companies try to cope with the costs of making up past deficits and hope to avoid the pain of increasing liabilities in future,” Altmann concludes.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.
A property chain is a line of buyers and sellers (the “links”) who are all simultaneously involved in linked property transactions. When one transaction falls through – for instance, someone can’t get a mortgage or simply withdraws their property from sale, the entire chain breaks and all the transactions are held up or even fail entirely.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.