The issue of pensions rose up the UK's political and industrial relations agenda during 2002 and is likely to remain there in 2003. Trade unions have increasingly been prepared to threaten or take industrial action over the closure of final salary occupational pension schemes and government policy on pensions is under review. This feature highlights key developments.
Final salary pension (FSP) schemes have traditionally been seen as the 'gold standard' of occupational pensions - the best option for workers. However, increasingly employers are replacing them with money purchase (MP) schemes. These are much less burdensome for employers, but more risky for workers. On 13 August 2002, following the breakdown of talks between the ISTC trade union (representing steel and metal workers) and the engineering firm Caparo Group, the UK's first-ever strike over the closure of a pension scheme took place. The ISTC claimed that its members would be 25% worse off when they retired under the new pension arrangement. John Monks, general secretary of the Trades Union Congress (TUC), has argued that closing FSP schemes is the first serious attempt to cut wages and conditions in the UK since the Second World War and has warned of a wave of strikes against firms that close down their schemes and offer inferior versions. So why have pensions become such a contentious issue in UK industrial relations?
Final salary pension schemes
FSP schemes are commonly seen as the most generous and most secure type of occupational pension. Under an FSP scheme, staff are guaranteed a certain level of pension benefits at retirement, based upon their final salary. No matter how badly the underlying investments in the pension fund perform, scheme staff are guaranteed to receive their money - the company bears the risk. This contrasts with MP schemes, where employers and employees make a fixed contribution and the size of the eventual pension depends on the performance of the assets in the pension fund.
Employers in the UK are increasingly arguing that providing FSP schemes is not financially viable. Some of the UK’s biggest companies - eg Allied Domecq (drink and catering), Daily Mail (newspapers), Rolls Royce (engineering) and Prudential (financial services) - have been named as having FSP schemes which are facing substantial shortfalls and many others - such as Abbey National (financial services), AstraZeneca (chemicals), BT (telecommunications), HSBC (financial services), ICI (chemicals), Marks & Spencer (retail) and Sainsbury’s (retail) - have already closed FSP schemes to new members. The 2002 employment trends survey (UK0210102N) published by the Confederation of British Industry (CBI) found that nearly a quarter of employers (24%) with a final salary scheme had closed it to new entrants in the past five years and a further 12% were considering doing so.
Companies blame several factors for the spiralling costs of providing FSP schemes:
- declining investment returns;
- the fact that retired workers are living longer; and
- the controversial new accounting rule known as FRS17, which requires organisations to offset all of their future pensions liabilities against a current snapshot of their assets, mainly shares.
Companies argue that complying with FRS17 forces them to provide information about headline surpluses or shortfalls in their pension schemes which are very misleading, but which can strongly influence stock market reactions.
Trade unions dismiss these arguments, pointing out that the move away from FSP schemes predates the FRS17 rule and putting the blame for the current shortfalls in pension schemes on suspension of employer contributions during years when share values were rising. This was often done in an attempt to avoid legislation which restricted tax relief on pensions if the value of assets exceeded 105% of expected liabilities. Funds that breached the rules had five years to reduce the surplus by cutting contributions, improving benefits or taking money out of the fund. Most companies opted for 'contribution holidays' and the savings from these could be substantial. According to Inland Revenue statistics, in the 13 years to March 2000 companies had saved GBP 18.57 billion by cutting or suspending their own contributions and taking refunds. It should also be remembered that the Inland Revenue keeps statistics only for those companies actually breaching the rules on surpluses, so the total company savings are likely to be far higher than GBP 19 billion.
In addition, many schemes have continued their contribution holidays. According to statistics from the National Association of Pension Funds (NAPF), 46% of schemes were still paying reduced contributions in 2001. Indeed, there has been speculation that pressure to close FSP schemes has come from institutional shareholders, anxious to see employers’ contributions removed from the balance sheet, thereby improving share performance, which might help explain why even companies with pension schemes currently in surplus are thinking of closing their schemes to new members. Even so, it is not just private sector schemes which are under attack. The government has also announced a review of its public sector pension schemes.
The move away from FSP schemes
Many employers are thinking of substituting MP schemes for FSP schemes. There are two main reasons for this:
- employers argue that operating an MP scheme will help to distribute the cost of pensions more evenly between employer and employee, by reducing the cost to the employer and placing more of the risk on the employee; and
- as has been strongly argued in local government, whilst existing schemes provide a good pension for those who put in 40 years’ service and retire at their peak salary, it is not so well focused on the pension needs of part-timers, employees who take career breaks, low-paid workers, contract workers or employees who work only in school term-time.
Neither of these arguments are as straightforward as they seem. The way in which many employers have sought to reduce the costs of the pension scheme is by taking the opportunity of switching schemes to reduce their contributions, leaving employees, who may not be in a position to make up the shortfall themselves, in a worse position. Furthermore, closing a scheme to new members is unlikely to make any material difference to company’s financial risks for the next 20 years, since there will still be hundreds of millions of pounds tied up in the defined benefit scheme. Only if the benefits owed are secured through insurance or government bonds will the financial risk actually be capped.
FSP schemes do tend to favour men over women, and 'time-servers' over mobile workers, since pension rights accrue with job tenure. Yet, while it may be true that some workers, especially the young, shift jobs more regularly, the amount of time spent with an employer by workers aged between 25 and 49 has not changed substantially over time. It is, therefore, not clear that changing to an MP scheme, for example, would necessarily benefit local government workers, many of whom are on relatively modest pensions. Indeed, as one firm of financial advisers specialising in advice to local government workers has pointed out, stock market returns have diminished so sharply that even a short period in an FSP scheme may be better value than an MP arrangement.
While MP schemes may not be inherently bad, they do involve a transfer of risk from employer to employee. The UK pension system has traditionally been based upon the shared responsibility for pension provisions by the state, employers and employees. Unions argue that the move away from FSP schemes is evidence of the desire by employers to retreat from this position.
However, not everything about FSP schemes is good. Many employees are unaware of the extent to which the preservation of their pension benefits in an FSP scheme depends upon their employer staying in business. Unlike the USA, where companies pay insurance premiums to ensure that all members of the scheme will receive a minimum benefit should the company close, in the UK both company insolvency and voluntary winding up of the scheme can leave scheme members without the benefits that they thought were guaranteed. If a company becomes insolvent, the fund is divided up and those who have not yet retired can be left with nothing. Similarly, when the employer closes the scheme for other reasons members are likely to receive only 70%-80% of the amount they have accrued.
Employee responses
Employers seem to have miscalculated the strength of feeling over pensions as well as trade unions’ willingness to strike. In fact, pensions were one of the most high-profile issues at the 2002 TUC conference (UK0210101N), marking out a new battleground between employers and employees. John Monks’ declaration that he was 'militant' on pensions, and that 'if people are messing around with pension entitlements, I can’t think of a stronger argument for strike action,' should have sent a strong message to employers, as should the fact that the Caparo steel group was forced to reopen its FSP scheme, on a revised basis, after an unprecedented series of strikes. Indeed, with pensions high on the agenda, the Guardian newspaper argued that, for the first time since the 1980s, the 2002 TUC conference was a 'heavyweight political event'.
The determination to fight FSP scheme closures appears to be strong. In a recent survey of shop stewards by Amicus, Britain’s largest manufacturing union, more than 90% said that they were prepared to strike in defence of final salary schemes. A one-day strike in October 2002 by Transport and General Workers’ Union members over the planned closure of the FSP scheme at Yuasa Automotive Batteries led to the establishment of a working party to develop alternative proposals. Workers at Prudential, BAE Systems (engineering) and ASW (steel) have also threatened strike action over the possible closure of their FSP schemes. According to Mr Monks, this new militancy stems from 'careless signs of corporate greed, like ever-rising salaries and huge pensions, while at the same time decent pensions are swiped from their staff - these kinds of things will promote militancy, particularly in a period of fullish employment'.
The wider pensions picture
The move away from FSP schemes also needs to be seen in the wider context of pension provision in the UK. The average pensioner currently receives 60% of their income from the state and 40% from other pensions. The state retirement pension is linked to prices, rather than earnings, so where earnings are rising faster than prices (as in the current economic climate) the real value of pensions declines. Both major political parties in the UK have argued for a reduction in the state contribution from 60% to 40%, but this comes amidst warnings from the TUC that more than 12 million workers in the UK are without an occupational pension scheme at all and that unskilled workers fare particularly badly (according to Prospects for pensions, TUC, June 2002). Among male professional workers, 76% have an occupational pension, compared with only 34% of male unskilled workers, and the split is even greater for women with 71% of female professional workers having an occupational pension, but only 27% of female unskilled workers.
Analysis from the TUC also suggests that the new stakeholder pension schemes - introduced by the Labour government as the 'poor person’s solution' to pension provision (UK0103119F) - are doing little to deliver people from the prospect of poverty in old age. According to the TUC, the average employers’ contribution of only GBP 44 per month is GBP 250 less than needed if pensioners who save each month of their working lives are to enjoy a pension of half their salary.
The TUC believes that the only solution to the country’s pensions crisis is a new 'partnership for pensions' between government, employers and employees, and has backed calls from a number of its major affiliates for legislation on pensions. It wants to force all companies to provide more substantial pension schemes, with a 10% contribution from employers and 5% from employees. Employer contributions have been compulsory in Australia since 1992 and now stand at similar level to that proposed by the TUC. The TUC also wants to make it compulsory for workers to join the schemes and for 'pension pay' to be given the same level of protection as current pay.
However, John Cridland, the deputy director-general of the CBI, has argued that compulsory employer contributions would threaten the viability of many smaller companies. Instead, the CBI has been in discussions with NAPF, whose members manage schemes for 8 million people with final salary pensions, over alternatives to shutting FSP schemes, such as establishing so-called multi-employer schemes where 'like-minded' companies establish a single scheme for all their employees, or schemes where pay-outs are based on an employees’ average salary over their whole career.
The government's green paper
In contrast to the TUC’s calls for partnership, the Pensions Policy Institute (formed from a former government advisory group on pensions) has argued that there are only two ways out of the pension crisis - people need to work longer and to save more. These themes were strongly echoed in the government’s green paper on pensions, published on 17 December 2002. The green paper includes proposals for the biggest-ever tax simplification of pensions and outlines legislation to encourage people to work longer and to discourage early retirement, although there is to be more flexibility in the rate at which workers can build up their pension, and what they can do with the money at retirement. For example, on retirement, workers would be able to wind down gradually by working part time and drawing a pension.
There is also no comfort in the green paper for members of FSP schemes being wound up, and little for those in schemes that might be wound up in future. The government is merely consulting on better protection, rather than moving forward quickly with any change. FSP schemes could also become less generous in future. They may be allowed more flexibility in the benefits they provide, as a means of cutting costs. For example, they could choose not to offer pension increases or widows’ pensions. Rather than make employer and employee contributions compulsory, a new standing commission is to be established to keep the case for compulsory contributions under review.
The green paper proposals have received a mixed welcome. Whilst the CBI has been broadly supportive, some employer groups, such as the Engineering Employers’ Federation, have argued that the government needs to go further and set firm target dates for implementation of its proposals. Unions have been particularly critical of the appointment of the head of the new commission on compulsion - a former CBI leader known to oppose compulsion - and of the fact that the commission has no trade union voice. Most criticism, however, surrounds the fact that none of the proposals are designed to make saving for retirement more attractive for individuals, especially those on low incomes who would still face the disincentive of losing out on means-tested state benefits because of a small private pension.
Commentary
Closing existing FSP schemes involves a unilateral change in the terms and conditions of a long-term contract. Breaking final salary promises to employees in their late 40s or older may mean a cut in remuneration from which they will suffer long into retirement. That is a worrying prospect, particularly for those on low pay and with little savings. Where the closure of such schemes is combined with large 'pay-outs' to highly paid executives, draining the fund of a large proportion of its assets, companies should not be surprised that employees feel both determined and bitter over pensions issues. Imposing a change at short notice, with insufficient compensation for employees, is a breach of trust going to the heart of the 'psychological contract' between employer and employee and hardly likely to engender commitment from employees.
In any case, it is not clear that such action is necessary. The John Lewis Partnership retail group, for example, far from closing its (non-contributory) FSP scheme, wants to raise its contribution from 9.8% to 10% of total paybill. The compromise reached at Caparo shows that employers and employees can reach sensible and practical solutions to the pensions problem.
At its core, employers’ handling of the pensions issue in the UK amounts to an attack on the most basic terms and conditions of employment, designed to reduce short-term employer costs. We should not be surprised that unions have reacted in the way they have. The USA is experiencing increasing industrial action over employers’ attempts to reduce the costs of employee health and safety benefits. While ending FSP schemes may enhance 'shareholder value' in the short term, their closure will do little to help recruit and retain a quality workforce and will have a substantial adverse impact on the morale of existing staff, who are important stakeholders in the organisation. The impact of this on shareholder value in the long term remains to be seen. (Helen Newell, IRRU)