Occupational Pensions
A new age?

The UK government faces a crucial set of decisions concerning occupational pension schemes. These decisions will have lasting effects on old-age income and the personal financial services sector in Britain. Much of the recent discussion of pensions has focussed on the State Earnings-Related Pension Scheme (SERPS), yet already occupational pension provision plays a larger role in Britain than is typical abroad. Government policy promises a wider role for occupational schemes and wider competition between pension providers in a little-noticed 'Big Bang' of its own. In Discussion Paper No. 99, Leslie Hannah examines the consequences of forthcoming legislation for the pension funds and for pension holders.

A key element in the future pension equation, Hannah argues, will be the creation of new alliances between employers and financial services companies designed to contain costs and exploit the marketing advantages now offered to the private sector. The key dangers posed by the more competitive environment will be increased risks of pension fund insolvency and undesirable cross- subsidies from tax reliefs.

Hannah identifies several reasons why the government proposals were likely to stimulate a resurgence of defined contribution ('money purchase') pensions. First, at the time the labour is employed their costs can be assessed more accurately than can final salary schemes. Second, even smaller schemes offer benefits whose value in real terms can be more accurately forecast now that index-linked securities are available, so that adequate pensions consistent with retirement objectives can be planned well in advance. Third, money purchase schemes now offer improved portability and balanced protection against inflation, both before and after retirement, in a manner earlier money purchase schemes did not. Last, money purchase schemes avoid the inegalitarian cross-subsidies which were a (probably unintended) by-product of final salary schemes.

But the question of pension portability has not yet been adequately resolved, Hannah warns. Unless there are clearer guidelines on transfer values for leavers, many employers will wish to preserve final salary pensions because they provide an 'actuArial,Helvetica,Sans-Serif smokescreen' which allows them to avoid some of the consequences of new portability rights. The legislative changes of 1973-85 on pension portability have gone a long way to establish the right of employees with five years' service (two years, after 1988) to take their accrued pension entitlements with them (or get a deferred pension) when they change jobs. But deferred pensions are only inflation-proofed to a maximum of 5% per annum. Neither employers or employees can easily determine the ultimate value and hence the true portability of a pension unless they can forecast inflation rates three decades hence. If the current surpluses in pension funds are to be used constructively, then government compulsion would be useful: voluntary progress in this area has proven to be slow. Further changes will probably also be required, Hannah argues, to standardize the actuArial,Helvetica,Sans-Serif guidelines on transfer values.

The 'Big Bang' in pension provision may also create new financial strains. Whereas large pension funds have become insolvent in countries such as the United States and France, British pension funds have an enviable record of stability; but the structural change they are undergoing leaves no room for complacency. Hannah predicts that insolvency of occupational pension funds is likely to become more common. Competition between the new pension providers - banks, unit trusts and building societies as well as insurance companies - will raise new problems of solvency standards.

Whereas the state pension system in the United Kingdom is relatively cheap to run, alarmist predictions have been made that personal portable pensions will increase costs to the levels common in present schemes for the self-employed, in which expense ratios can be as high as 20%. If so, Hannah argues, increased private provision will seriously reduce old-age savings in Britain, merely increasing employment in financial services. Hannah argues that employers will have sufficient power under the new system to contain the increased costs which will result from increased flexibility and the rights to contracting out. It is possible, Hannah notes, that employers will cooperate with the new pension providers, in order to provide new financial service packages. Such packages would allow employees to channel their savings for purposes such as house purchase or life insurance through their occupational pension schemes. This would tend to increase the efficiency of financial services retailing, but Hannah warns that such schemes should reflect the real costs of transacting business. On present indications, however, tax reliefs will play a larger part than real costs in the evolution of the system, Hannah predicts.

Leslie Hannah discussed the 'Big Bang' in occupational pensions at a CEPR lunchtime meeting on 24 February. A full report of this meeting appeared in Bulletin No. 13.


Occupational Pension Funds: Getting the Long-Run Answers Right
Leslie Hannah

Discussion Paper No. 99, April 1986 (HR)