Given that retirement scheme assets in the UK at the end of 1998 were $1,159bn (e1,340bn), it would surprise the visitor from Mars to discover that these assets will provide supplementary pensions for only half of the workforce on retirement. The second surprise would be provided by the fact that these schemes are entirely voluntary.
This does not mean that the state pension is so generous that uptake of supplementary pensions is unnecessary. On the contrary, it is generally accepted that the statutory provision is no longer intended to provide an adequate pension on retirement. Linked to prices rather than wages since the early 1980s the true value of the pension has been eroded to such an extent that it now represents as little as 20% of average earnings.
Membership of the scheme is compulsory from the age of 16 until the pension is taken. Contributions as at April 1999 were employer 12.2% and employee 10.0%. Entitlement to the full pension is calculated on the basis of contributions over a working life, with pensionable age currently 65 for men and 60 for women, although a single age of 65 is being phased in. Although early retirement is not possible, retirement can be delayed for up to five years with a bonus paid on take-up. The five year limit is also due to be phased out over this decade. Where the full contributions have not been paid reduced pensions are payable. This is most definitely a PAYG scheme.
The flip side of this is that the section of the population that has access to occupational pension schemes is on course for a secure retirement thanks to the development of a sophisticated asset management industry, and Britain’s developed financial markets. At the moment approximately 60% of pensioner income emanates from the public purse and 40% from private sources. The government, although seeking to avoid doing any damage to the private sector which is performing well, is keen to reverse these figures.
With the demographic outlook for the UK slightly better than many of its neighbours – the proportion of the population over 60 by 2020 is forecast to be 25.5% – the government may well be able to hit this target.
The first scheme introduced by the government to supplement the basic entitlement is the State Earnings Related Pension Scheme (SERPS). This was introduced in 1978 and is accessible to employees who have made national insurance contributions on earnings in excess of a lower earnings limit, set at £66 a week, for more than 12 months. Originally the benefit accruing under this scheme was to be calculated on the basis of 25% of the best 20 years’ earnings, but this has now been reduced on a sliding scale until 2010 to 20% of career earnings since the inception of the original scheme.
To encourage the take-up of private pensions the government allowed employers to opt out of SERPS, but insisted that they provide an occupational pension option for employees. Again such schemes were to be voluntary.
This has been one of the success stories of UK pensions. Most medium to large companies sponsor pension schemes for their employees, and this means that as much as half of the workforce is covered by such a scheme. These are mainly defined benefit schemes, but recently there has been an upsurge of interest in defined contribution funds. The reason for this is two-fold. Firstly, many employers feel that it is the most appropriate format for their employees. But behind this may be the fact that regulatory restrictions are far more lax on DC schemes than they are on their DB counterparts. Although voluntary schemes, the regulations laid down by the Department of Social Security on minimum standards, and the Inland Revenue on what benefits can be paid out whilst receiving tax concessions, have a big influence on the design of pension plans. The introduction of a minimum funding requirement has also had a major impact, with the aim of ensuring the health of these schemes.
Another curiosity of UK funds is the fact that despite the fact that all assets are theoretically tied to future pension demands, successive governments have encouraged funds to spend a proportion of their surpluses on charitable gifts and ‘good causes’. Last year the prime minister even lectured asset managers on the efficacy of venture capital investment.
With 40% of the private sector covered by occupational plans, and almost all local authority employees benefiting from an additional pension, the government suspects that it may be difficult to further expand this form of supplementing the state pension. Because almost all plans are sponsored on an individual company basis, multi-employer or industry-wide plans are almost unheard of, due to the lack of social contract collective bargaining.
The government’s chosen solution to expanding pension cover are a new second state pension and the so-called stakeholder pensions. In the case of the latter it is hoped that they will provide economies for employers, particularly small to medium sized companies, allowing many more members of the workforce to benefit from pensions through a centralised group of providers. The government is limiting the charges associated with these funds. As a result, some critics have said that the government seems to be confusing cheapness with quality, and that the scheme needs a re-think.
Several areas of concern have been identified by the industry. Some feel that, by setting exacting standards of governance and control, the government may not provide sufficient commercial incentive for many stakeholder schemes to take off. The government has suggested that a stakeholder pension manager would operate in the services company setting up the plan. The role would be similar to that of a trustee in a pension fund, and be regulated by the Financial Services Authority (FSA). The regulation of marketing and advice given will also be the remit of the FSA, while the Occupational Pensions Regulatory Body (OPRA) will be charged with stakeholder scheme registration compliance. Schemes will also be required to supply members with detailed projections of potential benefits.
There is also concern that many of the providers of the new funds will suffer financial losses in their early years. There is also concern that short contract employees must be offered membership. The government is stipulating a six-month waiting period, but industry insiders feel that two years employment should be the minimum.
UK pension funds have leant heavily on external service providers for asset management. They also use consultants far more than Euro-zone countries to get advice on management issues, asset liability and performance measurement. This means that almost 90% of UK pension assets are out-sourced to external management. What is more, pension funds are now employing a record number of asset managers, having on average doubled the number they employ from two to four during the past five years.
The task facing the government and the industry is an arduous one, but one which must be tackled swiftly if a substantial part of the workforce is not to face impoverishment on retirement. A second state pension and stakeholder pensions may or not be the solution, but discussions should continue apace.
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