Alan Shipman is editor of FinanceWeek.co.uk: The satisfaction of closing occupational pension fund deficits could soon be offset by the arrival of the Pensions Act, which does not disguise the up front cost to organisations of matching employee contributions after 2012.The satisfaction of closing occupational pension fund deficits could soon be offset by the arrival of the Pensions Act, which does not disguise the up front cost to organisations of matching employee contributions after 2012.
Most of the business gains from a fully funded system and a higher-growth economy will appear only after 2050. But the early expense is best viewed as a down-payment for ensuring good workplace relations, between one generation that seemed to have it all and another that pays for it all.†
Until this year, pension self funding took place mainly through private schemes or the defined contributions (DC) to which most occupational plans have now switched. Now the government has made its pitch for universal enrolment with personal accounts (PA). Employees will, from 2012, be required to pay at least 4% of their annual pay into these, unless they opt out into another occupational or private scheme. Employers must match this with a contribution of at least 3%, the government offering a further 1%through tax relief.†
The government’s own cost-benefit analysis of the reform, published by the Department for Work and Pensions (DWP) in December, focuses on the benefits to today’s workforce when they retire. Employees are shown as paying, on average, £7bn per year in PA contributions between launch and 2050. But in return, they are promised an increase in net pension flows of £15bn a year by 2050.†
The change is also credited with delivering an estimated £40bn benefit from ‘consumption smoothing’ – the ability to redistribute income across their lifetime to get maximum benefits from it.†
Before 2050, however, the assessment is more downbeat, since most of the transition costs are incurred before the benefits start arriving. Brown and Darling are not exempt from the stern economics that suggest the government must pay a large lump sum to compensate the changeover generation from having to pay twice.†
So, compared with the US (with its more sanguine approach to public debt) and some parts of continental Europe (with greater willingness to fund a higher state pension through tax), more of the UK cost is likely to fall on private employers.†
The DWP projects an annual average collective employer contribution of £5.5bn under the new arrangement, substantially more than the £2bn that the Treasury expects to pay through tax relief and additional outlays on the state second pension. Employers will also bear a cost for administering the new PAs, though official calculations put this cost at less than £500m.†
In the long run, employers are shown as gaining directly from reducing the revaluation cap on deferred pension to 2.5% from 5% (saving business an estimated £250m per year on average), and indirectly from a faster-growing economy. The Treasury calculates that higher savings through the reform will add 0.2% to the sustainable growth rate. Faster growth is the only way to ease the pain of adjustment, so there’s less struggle over how it’s distributed; and most economic assessments suggest the viability of a pension arrangement depends far more on how well it promotes full employment and expands national resources than on how efficiently it distributes resources.
Employers may also benefit from the estimated £1bn plus (at today’s values) savings on the government’s welfare bill after 2050, which might find their way through into lower tax – or at least avert the increase that would otherwise be needed.
These are only broad estimates of cost and benefit, averaged across a timeframe that gives forecasts a large margin of error. Business may end up incurring a smaller cost in the early decades if, for example, more employees are persuade to switch to improved private pensions. But if substantial transition costs do fall on employers, rather than the government, ministers will argue –with some justice – that this is a commercial cost to offset a social cost that employers might otherwise find equally expensive.†
The double-paying generation does not work in isolation. It teams up with, and takes orders from, older colleagues, many of whom are lucky enough to have locked-in pay-as-you-go pension provision. If you’ve closed a defined benefit (DB) scheme, and channelled new recruits into DC plans, you have guaranteed the retirement benefits of the more senior staff while leaving the juniors to see what the stock market lottery brings them. Worse, from the perspective of newer employees, the guaranteed benefits of that DB generation – who, actuaries now know, will go on drawing for 20- 30 years after normal-age retirement – can be attained only through an active transfer of risk on to the new DC generation. The upshot is that it’s likely to cause real friction between young and old workers.
As retirement ages rise, many firms will end up with five generations mixed together on their payroll. Their attitudes and behaviours are known to be different, and may require different treatment by line managers and supervisors. But their financial aspirations show a lot of uniformity, and they expect equal treatment by the finance division, even if enrolled in different pension schemes.†
It’s going to be hard for large employers to maintain trust unless they go along with the additional costs of which the Pensions Bill – now completing its parliamentary passage – clearly forewarns.