Systems ‘unsustainable’

Look at the future of retirement saving, and it is not a pretty sight. This was the message from Matthew Young, director of special projects at the Adam Smith Institute, to the Pensions Management Institute’s spring conference. With the loss of 0.5% of the workforce every year in the UK, it is estimated that by 2030, 1.5 people will be supporting each pensioner. It is an “extraordinary burden”, said Young, and a situation he considers will be much worse in Europe, where generous state funding has led to a higher tax take of GDP. With an ever increasing ratio of dependents to workers in the UK, Young believes “the risks and weaknesses inherent in both state and private systems are substantial. The state system is unsustainable and makes no provision for future liabilities. The private funded pension is complex, costly and it underperforms. Neither system can survive without fundamental reform.”
State pay-as-you-go is “fundamentally unsustainable” and will “self-destruct” because people will not save enough. The economic impact on pensions – of demographics, European monetary union and poor equity returns – are the fundaments of what is being faced.
In light of projected equity performance, Young felt that a turning point was being reached and the consequences for asset allocation will be seen in pension fund exposure to equities – currently high – as alternative views are sought. Cost reduction, incentives for people to save to escape the legacy of dependence prompted by the welfare state system, are where Young believes solutions will be found.
He also believes there is a serious need for regulatory simplification, a point picked up on by Robin Ellison, national head of pensions at law firm Eversheds, who believes that “the regulation of pension schemes is doing more damage to pension scheme members than Maxwell ever did; the paradox is that less regulation might lead to better benefits for more people. If some people lose out, that might be a price worth paying”. It was important to “get the balance right between consumer protection and withdrawal of employers from pension provision.”
When it came to discussion of the FRS17 accounting standard, “reporting the situation doesn’t change the funding questions,” said Mary Keegan, chairman of the Accounting Standards Board. “Those who blame FRS17 solely for today’s pension problems may have missed the point,” said Brian Peters, director of PricewaterhouseCoopers. “Regardless of its technical merits, FRS17 has brought to the attention of UK management the risks associated with running defined benefit pension schemes. These are not limited to stock market investment. They also include low inflation and longevity. The problem for UK management with FRS17, is that the shareholders will now be able to see clearly the consequences of taking risks when running a pensions scheme.” Although recognising that FRS17 had led certain companies to re-evaluate their pensions arrangements, Peters raised the question of whether such a response was a cause or a symptom of the current pensions crisis, given that many companies had “already moved towards defined contribution a long time before FRS17 was issued”.
Certainly, he agreed, challenges have been faced in the application of FRS17 accounting standard including difficulties in delivery within the set time frames; a more detailed audit process then was expected; investor relations challenges and the realisation by companies that their pension funds create “significant risk”. In this sense, says Peters, FRS17 has truly engaged the company in pension risks and therefore issues of investment underperformance, manager underperformance, longevity, inflation and overall risk measurement. He believes that in looking ahead, some companies may “ultimately not be able to pay dividends because of FRS 17”, which he sees as the next big issue.
As for which pension accounting standard will be adopted once international accounting standards become mandatory in 2005, the debate continues.

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