If you're a member of a defined-benefit pension scheme that offers generous guaranteed benefits once you retire, don't assume you'll receive everything you've been promised. Under proposals published by the government this week, employers in financial difficulties may be allowed to water down their promises.
Private-sector employers in the UK operate about 6,000 defined-benefit schemes. Most are now closed to new joiners, but have about 11 million active, deferred and retired members. Typically, such schemes guarantee that once people start claiming pensions, their benefits will be increased each year by an amount that at least matches the inflation rate, as measured by the retail price index (RPI). But now the government is suggesting that companies struggling to stay afloat should be allowed to switch to using the consumer price index (CPI) measure of inflation, which is typically lowerthan RPI.
An estimated 5% of businesses are in this financially "stressed" category, according to the green paper. In the most serious cases of financial difficulty, employers might even be allowed to suspend pension increases temporarily. If all defined-benefit schemes were given the CPI option, their combined funding deficits the extent to which their assets are insufficient to cover their liabilities would come down by £175bn, according to research published last year by actuary Hymans Robertson. But the retirement benefits of the average scheme member would fall in value by £20,000.
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The proposals will be controversial. Employers' groups such as the Confederation of British Industry (CBI) have argued that defined-benefit pension schemes were designed at a time when average life expectancies were shorter and financial markets were delivering higher returns. The rising cost of such schemes is inhibiting businesses seeking to invest for the future, the CBI suggests, and holding back money that could go towards employees and shareholder dividends.
Employers also point out that when a company goes bust, pension scheme members must rely on the Pension Protection Fund (PPF) for their pensions. Under the PPF, members receive an average of £45,000 less than they would otherwise have got, according to Hymans Robertson. Not giving leeway to firms in financial difficulties may, therefore, end up costing scheme members even more.
The counter argument is that any moves to abandon pension guarantees could make it too easy for firms to renege on their obligations. "There is a significant risk that relaxing standards on inflation protection with the best of intentions for exceptional cases could be exploited and lead to millions of retired people being at risk of cuts in their real living standards," says Steve Webb, a former pensions minister.
In addition, it's not clear whether such radical action is needed. While many employers have sizeable pension scheme deficits to address, the picture can change quickly, even with small adjustments in financial markets. Last summer the UK's defined-benefits schemes faced a collective deficit of about £460bn, according to industry analysis. This figure has since more than halved, largely because of a rise in government bond yields, which are crucial in valuing pension scheme assets and liabilities.
Should the regulator get more powers?
The proposals (see story above) include measures designed better to protect members of defined-benefit pension schemes, who have often been put at risk by the actions of their employers. Campaigners point to the recent BHS case, in which the failure of the business resulted in pension scheme members and the Pension Protection Fund being left substantially out of pocket.
Another proposal is to give greater power to the Pensions Regulator, the watchdog that oversees much of the occupational pensions sector. The regulator could be given new rights to scrutinise corporate actions, such as takeovers and mergers, and to intervene where it judged such transactions were likely adversely to affect pension schemes' security.
Giving pension scheme trustees more responsibility would be another way to safeguard members' interests, ministers believe, particularly if accompanied by new requirements for training and professionalism. Trustees would also have to explain their actions to the regulator when they fail to comply with guidance.
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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.
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