In the good old days, if you were lucky enough to work for a large employer, you were provided with deferred pay (and an incentive to leave and make way for younger people) in the form of a defined benefit pension scheme to which both you and your employer contributed. The defined benefit usually took the form of a combination of lump sum, payable on retirement, and pension (usually a fraction of final salary) payable until death. A fraction of your pension was then usually paid to a surviving partner if you died first, and there was usually some sort of index linking so you were not caught out by inflation. The state encouraged you to save via such schemes by offering full tax relief on contributions, knowing that withdrawal from the scheme (other than lump sums) would later be taxed in full.
This system was designed in the post-war Beveridge years for a society with full male employment, jobs lasting 40 years, and where only one wife in eight did waged work, and where neither husband or wife expected to live more than a few years post his retirement. The minority of women who joined pension schemes contributed much less than men because they were less well paid and they took time out to raise families. The generality of women, the low paid and the self-employed had to rely on relatively modest state pensions plus their own savings.
This all fell apart due to a number of factors:
- Fluid families have subverted the world that Beveridge imagined. Today, half of all marriages end in divorce, more than half of all children are born outside marriage, and women are seldom financially supported by their husband or partner.
- People (to some extent unexpectedly) began to live much longer, thus increasing the period for which pensions fell to be paid and so increasing the liability of employers.
- Real interest rates fell, again requiring employers to fund the shortfall.
- Seeing the large amounts held by then tax-exempt pension funds, politicians began to tax the funds, thus again increasing shortfalls.
- New accounting standards and the aftermath of the 2008 financial crisis have also made traditional pensions too unpredictable and expensive for employers.
- It became clear that traditional pension schemes were great for wealthier men - who received the most tax relief and also typically lived longer - and were not so good for women and for those on low incomes whose pensions were, by definition much smaller, and who tended to die younger than their wealthy neighbours.
For example, a combination of the above reasons led to the pension liabilities of BA and many other companies becoming several times greater than their annual turnover.
The result was that many pension schemes were closed to new entrants, forcing employees into defined contribution schemes - basically savings schemes where the pensions will eventually depend on (a) the amounts paid in before retirement, and (b) the investment performance of the scheme. Governments also increased retirement ages, reduced tax relief for contributions, and improved the attractiveness of the state pension.
Pension schemes have always been heavily regulated so as to ensure that their funds remain intact for the maybe 60+ years that they need to be invested on behalf of pensioners. But the pressure on pension scheme finances, and scandals such as BHS (see further below) have led to the current regulatory edifice being particularly heavy. Some say that the law, regulations, rules, codes, case law and guidance notes amount to around 160,000 pages!
It all pretty much began with the the Pensions Act 2004 which introduced two new regulatory institutions: the Pensions Regulator, with the powers to require sponsoring companies to make contributions to ensure that scheme funding objectives are met; and the Pension Protection Fund, which would inherit the pension liabilities of a pension scheme in the event that a sponsoring company became insolvent. But many believe that the Pensions Act was a prime example of well-intentioned but inept financial regulation.
There are two main problem areas:-
Pension Scheme Insolvency
Some schemes have failed to pay out their promised benefits after the parent company had gone bust. Sir Philip Green's BHS was a particularly notorious example. The company's collapse led to 20,000 members of the pension scheme facing reduced payouts - a prospect made all the more unacceptable as Sir Philip had removed huge sums from the company before he sold it shortly before it collapsed. It is well worth reading the Pensions Regulator's Regulatory Intervention Report which will help you understand the role and powers of the regulator, and which contains admirable admissions that it could and should have intervened more robustly in this case.
Pensions Mis-Selling - Personal/Self-Invested Pensions
Various legislation from the 1980s onwards made it much easier to transfer pension pots between schemes and - more dangerously - into self-invested personal pensions. In most cases, of course, such pension funds are not 'self-invested' but are controlled by professional advisers who are paid a fee for their services. This inevitably led to unscrupulous advisers persuading unsophisticated pensioners to transfer their savings out of defined benefit company schemes into badly managed personal pensions. Although there were plenty of warnings that this might happen, the regulators were slow to respond - or maybe they had insufficient resources - and politicians continued to introduce faulty legislation. I was struck, for instance, by this 2017 FT report :
At FTAdviser’s Unpackaging Pensions event last week, Keith Richards, chief executive of Personal Finance Society, said the government has repeated the mistakes of the 1980s with pension freedoms, which were introduced in 2015. At the time of the pension freedoms announcement, George Osborne, then chancellor, said that pensioners would have “complete freedom to drawdown as much or as little of their pension pot as they want, anytime they want". "No caps. No drawdown limits. Let me be clear: no one will have to buy an annuity,” he said, at the time. Since then, defined benefit pension transfers have been soaring, as savers seek to take advantage of sky-high transfer values and to move their nest eggs into defined contribution schemes in order to access them.
Patrick Hosking's column in the Times in early 2018 nicely summarised one scandal:
Everyone who works in the pensions industry should be led to a quiet room and forced to read the devastating parliamentary report into the terrible treatment of members of the British Steel Pension Scheme. Somehow, despite all the fine words and good intentions of regulators, trustees and advisers, despite all of the red tape that festoons the industry, and despite this being one of the biggest schemes in the country, no one seems to have been thinking about the poor souls at the sharp end. Like the member who phoned the pensions office 207 times without anyone picking up the phone. Like the 25,000 people so confused and paralysed by the paperwork they ended up doing nothing — probably to their great cost. Like the workers persuaded to sign their nest-eggs away at the whiff of a free “sausage and chips” lunch.
Financially unsophisticated people; very large sums of money (average transfer values were £400,000); mindboggling complexity; a looming deadline for action. It’s hard to think of a better combination of circumstances for the “parasites” and “vultures” who descended on old steel towns such as Port Talbot, Corby and Hartlepool in search of prey. This was a potential mis-selling scandal all too easy to foresee. Yet the Financial Conduct Authority and the Pensions Regulator were slow to respond. The trustees tried hard, but still didn’t do enough for confused members overwhelmed by such an important decision.
Until there is a cultural revolution among regulators and they start trying to anticipate such problems, these scandals will keep occurring. The rogues are energetic, persuasive, persistent and there in person. The regulators are complacent, busy with boxes to tick, and far away in Canary Wharf and Brighton. One potential reform MPs are right to push is outlawing the toxic practice of contingent charging. Under this, financial advisers get paid only if the member is persuaded to transfer out. It’s hardly a recipe for fostering impartial advice.
And new regulations, introduced the same year by the Financial Conduct Authority, do not give one confidence that the regulator had been alert and active over that 14 year period (emphasis added):
We are introducing rules and guidance aimed at providing advisers with a framework which better enables them to give good quality advice so that consumers make better informed decisions We are maintaining our guidance that an adviser should start from the assumption that a transfer will be unsuitable. This reflects the high proportion of unsuitable advice seen in supervisory work and need for further consideration of how transfer advice should be paid for. The existing guidance on the starting assumption does not, however, prevent an adviser from recommending a transfer where this can be demonstrated to be suitable for the consumer.
Collective Defined Contribution (CDC) Pension Schemes
It was reported in 2018 that Royal Mail plc hoped to persuade the government to legislate to allow these Dutch-style or defined ambition schemes to be operated in the UK. The Times' Patrick Hosking noted that their fans "see them as a way of boosting retirement incomes at not extra cost" but warned of the extra risks that would inevitably accompany such financial engineering. We shall see ...
Mervyn King and John Kay have written a very clear explanation of the unfortunate impact of that legislation on the Universities Pension Scheme.
And Geoff Meeks has written an excellent guide to Understanding Pension Obligations.