David Cule: £243bn pensions shortfall points to a long-term problem

Published on Saturday 18 April 2009 14:08

THE publication of another worrying set of figures last week highlights the black holes facing many private company pension schemes.

The Pension Protection Fund, the safety net which rescues members of collapsed schemes, calculates that the total assets held by UK private pension schemes are now 243bn short of the value of the liabilities that the PPF is expected to provide. This is the largest shortfall it has recorded in its four-year history of calculations.

But as the PPF's liabilities represent only some 80% to 90% of the actual liabilities of the 7,000 plus private pension schemes in the UK, the shortfall could in reality be much higher, at between 350bn and 400bn. These figures can be compared to the amount of quantitative easing (circa 150bn) and bank support (around 500bn depending on measurement), and so can be taken as serious sums.

Ironically it is recognised that quantitative easing has been a major cause of the recent increase in shortfall, since the high demand from the Government for its own bonds also increases the value placed on other long-term promises to pay – such as pension scheme liabilities – in market-driven financial comparisons.

So what are the options? We all know pension liabilities are long term –many of the payments are not due for 20 or 30 years, and there are more than sufficient assets set aside to meet payments until then. But what about the later ones, payments for people who have not yet retired but who believe they are entitled to some pensions from their employers?

Well, these payments are not so certain and this is what the shortfall represents. Such payments must be made up either from greater-than-expected investment returns or from more contributions paid in by the companies – from profits that could be otherwise paid to investors. Given the recent experiences we have had in the economy, neither of these can be taken as a certainty. This could mean that something has to give eventually, and the question is what. There seem to be several options and the likely outcome will be a mixture of them all.

Firstly, pressure from pension schemes will reduce the dividend-paying powers of some companies and thus lower the attraction of shares and reduce the returns made on such investments. So while helping the scheme of one company, overall this may harm schemes investing in equities as a whole. The taxman could help here by giving back the tax it has previously taken from pension schemes when Advanced Corporation Tax (ACT) relief was removed in 1997.

Secondly, schemes may have to reduce benefits. At present this is only possible if a scheme-sponsoring company goes into liquidation, which destroys both the company and potentially the jobs it provides. At this point the scheme enters the PPF and reduced benefits will be paid to members, and shareholders will have gained nothing from their investment.

Thirdly, the PPF may well find that it has promised too much and has to collect more levies to keep it viable. But these levies are collected from the same pension schemes that are already concerned about paying the promises they themselves have made, so perhaps the Government would step in here as well and meet these levies as a need to socially insure the private sector pension schemes (which of course it already does for public sector schemes).

Fourthly, the PPF may look to reduce the level of benefits it provides, not a politically positive move but one that economics may force on the arrangement. And if the PPF is allowed to reduce its benefits, will schemes also be allowed to cut back on benefits directly?

Finally, could the spectre of renewed inflation return, after the money printing of quantitative easing, and devalue the benefits due in 20 to 30 years? This will not, under the present regime, have any impact on the public sector arrangements but may ease the demand on the private sector, although at the price of other potentially more damaging pressures.

The UK pension dilemma will not be solved overnight. Some re-balancing needs to take place and this has already started with most company schemes only applying to staff who joined some years ago and many staff not accruing any benefits going forward. But more needs to be done and the PPF shortfall shows the problems are not going away anytime soon.

David Cule is principal at pensions actuary Punter Southall

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