The envy of the world: that, or so we were told, was the great British pension. Like the BBC or the National Health Service, this was an institution so much admired by foreigners that none of them dared copy it. We could sit at a desk for fifty years and hang our hat on a pension, worth two-thirds of our final salary — and all without apparent effort. It was an illusion.
Now, it has been shown the door by Royal Dutch Shell. This was the last of our hundred biggest companies (as measured by the FTSE index) to link its pensions to final salaries. The scheme will carry on — pension schemes do — but will be closed to new entrants. Shell, unlike some of its peers in the index, is big and strong enough to run whatever kind of pension scheme it still believes to make sense, and its verdict is decisive.
Gone for ever are the happy days when pensions seemed to grow on trees. The pension funds were so rich that their sponsoring companies took to giving themselves holidays and paying nothing in. Their employees took no holidays, but their money went into a pool and was subject to a process of cross-subsidy. Broadly speaking, those who moved on paid for those who stayed put and the shop floor paid for the boardroom.
Those who got sacked were the biggest losers of all. In the pension funds’ pitiless jargon they were classified as early leavers. A surplus director, by contrast, might be given early retirement on full pension, boosted by a timely increase in his final salary. It would help if his colleagues were the pension scheme’s trustees. The funds themselves became unannounced targets for takeover bids. In the end, Robert Maxwell, needing to raid his own fund, took one short cut too many.
What had made the trees so fruitful? First of all, a tax climate that served as a sun-trap. Companies’ payments to pension funds could be offset against tax, but were not taxed in the funds’ hands, and bore no tax at all until they came out at the other end as pensions. Even then, some might escape as a tax-free lump sum: “A much-loved anomaly,” said Nigel Lawson, who as Chancellor would have liked to get his hands on it.
Then the markets themselves came up with a record-breaking harvest. The 1980s and ’90s were wonderful years for investing in shares, and reached their peak at the end of the century. No wonder that Gordon Brown seized the chance that eluded his predecessor. He coolly withdrew the tax credit from dividends received by pension funds — a technicality worth £5 billion a year to the Exchequer. That was the day when the sun went in and the trap closed.
This century has been harder. Share prices have gone nowhere or gone backwards, to leave the index down by about one-sixth from its peak. In real terms (that is, allowing for inflation) far more has been lost, and pension schemes have to allow for inflation. Government stocks have had their overdue day in the sun — but by a quirk of the actuaries’ arithmetic, this has only served to widen the pension funds’ deficits.
Meanwhile, more is asked of the funds. The beneficiaries are inconveniently living longer. The schemes that are still solvent must now bail out those that aren’t, and the sponsors who stand behind them watch the bills mount up. Too late, they find out that they are now in the life assurance business, which, as the Equitable Life’s example shows, is not as easy as it looks. Some find that their business now comes second in the order of magnitude. British Airways was well known to be a life office with wings, and had trouble staying airborne. Others find that their pension schemes eat up the funds that they need for their own reinvestment, and their own survival.
No wonder, then, that their sponsors — Shell is only the latest — have been getting out of conventional schemes based on final salaries as quickly as they can, which is to say slowly, by closing the door to the newcomers. These schemes will be with us for another generation. By then the long cycle that seems to govern the stock market may have turned up again and the deficits may have melted away. All the same, the sponsors have been so thoroughly bitten that they must now be twice shy.
So they should be. Even in their heyday, such schemes were out of date, a relic of earlier ages when people might often be on the payroll of one big employer all through their working lives. Since then the six-figure payrolls have shrunk, and many of the employers are no longer with us. People, nowadays, can expect to live longer than companies.
They can also expect to move about in their working lifetimes, and so they should. A free market in labour is one sign of a healthy economy: a brake on mobility can only slow it down. A system that cross-subsidises the boardroom is objectionable in its own right. This used to be known as putting old George all square for pension. Old George has done quite well enough.
The conventional schemes provide what are called “defined benefits”. They are giving way to schemes based on defined contributions. Time and the markets, good luck and bad management — all of these will make a difference, but each pot of money has an individual’s name on it, and derives from the money put in, either by that individual or on his or her behalf.
Defined contribution schemes still leave the employers with plenty to do, by way of keeping the books, paying costs, finding volunteers to serve as trustees — what a mug’s game — and arguing with the actuary. Employers may continue to ask whether the provision of pensions is their business. Years ago, the courts established that pensions are deferred wages — but employers, when they pay wages, do not try to specify where the money goes. The recipients must decide that.
It would be better to say that pensions are the by-product of savings, but that we can all have different ideas about savings, different uses and different priorities. One use may be to buy a house, and one way to save is to pay off the mortgage. One way to avoid that is to live in a tied cottage, but tied cottages have had their day, and so have tied pensions. The choice should be ours, so long as we realise that pensions do not grow on trees and never did. That was always an illusion.
Governments, who like to think they know better, come up with successive schemes meant to solve our pension problems for us. Serps was one, stakeholder pensions was another. The next scheme in line is called Nest, and ought to be called Cuckoo. An employer who points out its disadvantages will be liable to prosecution, which scarcely suggests that it will be sold on its merits. To believe that governments can be trusted to look after us in our old age is the biggest illusion of all.