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The Actuary The magazine of the Institute & Faculty of Actuaries

The truth about pensions

The issue of pension security for members of occupational defined benefit schemes has suddenly become one of the most contentious debates in the UK pensions arena. Until the last couple of years, there was a general assumption that final salary schemes were ‘safe’ and the government, trustees, journalists, and all the major pensions industry organisations regularly assured members that their pensions were protected by the law. As a result of this general belief, members were lulled into a false sense of security that their benefits were guaranteed and that the government’s funding rules ensured that their accrued pension rights were safe.
Of course this is not and never was the case. Many thousands of scheme members, having saved loyally in their company schemes for decades and making no other provision for their retirement (prevented by Inland Revenue rules from diversifying their pension holdings) have ‘lost’ most or all of their promised pensions when their employers’ schemes have wound up. Many will not even receive their full guaranteed minimum pensions (GMP) which have turned out to be neither guaranteed nor a minimum. The effect of such stories on confidence in pensions has been devastating.

The new Pensions Bill
The new Pensions Bill currently going through Parliament proposes to prevent such a situation from occurring in future, by establishing an insurance arrangement, the Pension Protection Fund (PPF), funded by pension schemes themselves. This aims to pay out a pre-defined amount to members whose employers fail and whose schemes therefore have to wind up but have insufficient assets to pay all promised pensions. The aim of the Pensions Bill is to restore confidence and improve security for pensions. However, the PPF will help only those affected in the future, not those who have already suffered in the past. The government came under significant pressure to restore pensions to these wind-up victims. In the face of enormous media pressure, a potential Parliamentary defeat and threatened legal action by trade unions, the Treasury finally agreed to set aside a sum of money £400m to establish a trust fund to provide assistance to some of those who lost their pensions. However, this sum is nowhere near sufficient to make up for the amounts lost.

Parliamentary Ombudsman
The case for full compensation by government is overwhelming, both from a moral justice point of view and from a public interest perspective. I am now helping the victims approach the Parliamentary Ombudsman, to ask her to investigate maladministration and negligence on the part of the Treasury, the Financial Services Authority, and the Department for Work and Pensions.
The role of the actuarial profession will be highlighted in this appeal and it will be shown that the Faculty and Institute of Actuaries (FIA) tried to persuade the Treasury to ensure proper disclosure to occupational scheme members about the level of security for their pensions on wind-up. Reference will be made to the report by the FIA Pensions Board, prepared for the Treasury in 1999 and released in 2000, which examined the workings of the statutory UK minimum funding requirement (MFR). This report highlighted that scheme members and trustees generally believed the MFR offered them full protection when this was not the case. The actuaries’ report strongly recommended to the government that it should, at the very least, tell all classes of members what would happen to their pensions if the scheme wound up. The Treasury and Department of Social Security (DSS) consulted on the actuaries’ report and recommendations in September 2000 the document highlighted the strong advice from the actuarial profession about members’ mistaken beliefs regarding the safety of their pensions.
In fact, the consultation document stated that:
‘The government wants to help people understand their pension rights and appreciate the value of saving for pensions.’
It also stated that, for defined benefit schemes, ‘there is no intrinsic guarantee that the accumulated funds will be able to deliver members’ pension rights’. The document emphasised that one of the ‘key conclusions’ of the actuarial profession’s report is the strong recommendation:
‘ that the new MFR test should be coupled with much clearer disclosure of the real position regarding the security of members’ benefits in the event of the scheme winding up, for each class of member.’

Members not consulted
Sadly, however, the government failed to discuss this with the interest group most affected the scheme members themselves. Furthermore, in its response to the consultation, in March 2001, the Treasury and DSS ignored actuaries’ advice and decided not to warn members. Worse than this, however, even after the consultation exercise, the Treasury, the DSS renamed the Department for Work and Pensions (DWP) and even the regulator, the Financial Services Authority (FSA), continued to tell members of final salary schemes that their pensions were ‘guaranteed’, ‘safe’, and ‘protected’ by the law. The DWP continued to promote and encourage joining employer schemes. There was not one mention in any official document of the risk of losing pension rights on wind-up.
The government, in effect, failed to act with due care and hopefully the Parliamentary Ombudsman will thoroughly investigate this dreadful injustice and ensure proper compensation is paid. After all, the effect of this situation is that members were robbed of the opportunity to protect their pensions and were lulled into a false sense of security over the safety of their retirement income. Many members who lost pension benefits were in their 50s or 60s, and relying totally on their employer-sponsored pension benefits to support them in retirement. They have told me that, if only they had known their money was not safe, they would have transferred their benefits out of the scheme.

Lessons to be learnt
There are several consequences of this situation. Having been ignored in 2000, actuaries have learnt a valuable lesson. Most importantly, the actuarial profession is to be commended for publicly questioning the government on its misleading description of the safety provided by the proposed PPF at the earliest possible stage. If only the actuarial profession had been more forthright in 1995 about explaining to scheme members what the true level of security provided by the MFR was, the scandal of wind-ups could have been less harmful. If members had been warned there was a risk that their pension might not be paid, they would have had the opportunity to decide whether they were willing to take such a risk. Many of those with much to lose would never have stayed in a scheme had they known it depended on the continued commitment of the employer. By falsely leading members to believe that they were protected by the funding safeguards put in by the 1995 Pensions Act, confidence in pensions has been dreadfully damaged.
It is vital the government does not introduce new measures in the current Pensions Bill with similar false assurances. If PPF benefits are not ‘guaranteed’, members should be told the truth. Unless there is a government underpinning for the insurance scheme, in a worst-case scenario it is clear the PPF may not pay anything like 90% of the pensions of non-retired members. Members must be made properly aware of this or, preferably, the government should provide such an underpinning of last resort. The actuarial profession should be commended for taking a stand on this issue at such an early stage and insisting on revealing the true situation to scheme members before damage is done. I also fully agree with the Association of Consulting Actuaries which has argued for pensions in payment to be capped at the same level as deferred or employee members’ pensions. The cost of replicating full, high-level, index-linked pensions could be enormous and should not really be the purpose of the PPF.

Fundamental change
We are undergoing a period of fundamental change in pensions. The government has recognised that members’ rights were not properly protected, nor were the interests of those not yet retired fairly safeguarded. However, scheme members were led to believe that they could rely on their employer to fund their pensions for them and did not realise they had to take care of their own futures. Employers often funded schemes at a bare minimum level, comforting themselves with the knowledge that they could always wind the scheme up and would only have to put in enough to meet the MFR, even if that meant decimating the non-retired members’ promised pensions.
Even worse, many venture capitalists used pension funds as an easy means of corporate restructuring on the cheap. They could financially engineer the company to offload expensive pension liabilities to a new, weaker subsidiary, sell off any profitable assets, and then let the subsidiary fail, leaving pension scheme members without their pensions. Of course, the loyal workforce, continuing to pay their contributions, were totally unaware of these machinations and were the ones who paid the price for the profit of many venture capitalists, or helped to fund the management buyouts of failed firms. Management, sometimes led by venture capitalists, often repurchased the company from the receiver, having jettisoned the pension liabilities and the future security of the members. It was always the ordinary members, who were least able to understand pensions and most vulnerable to scheme underfunding, who suffered. This is not conducive to engendering confidence in pension schemes when things go wrong.
The measures of this Pensions Bill have shifted the balance of power away from the employer, to give more rights to members and increased responsibility to trustees. This will be an important development and the implications for funding of employer pensions and security of benefits should be properly explained to all the interest groups. The most important lesson we can learn from the pension disasters of recent years is that ordinary members must be told the truth. The time for false assurances is long past. If final salary private-sector pension schemes are not reliable, members must be warned. It is not good enough to claim that ‘most people’ have received their promised pensions. The thousands whose lives have been destroyed are not just an ‘unfortunate accident’ it could happen to anyone. If the government wants to make pensions safe, it will need to underpin the PPF. As regards certainty or security for future pensions, if we truly want to restore confidence, it is vital that we should tell it as it is.