It cannot be said that the current pension settlement in the private sector is intergenerationally fair. Retired workers’ “gold-plated” final salary pensions are receiving contributions that are 20 times more expensive than those for younger staff, and are ruinously expensive in the light of ageing populations and low returns on investment.
That so many older people on final salary pensions also chose Brexit – in spite of expert warnings of the turmoil it would cause to the financial markets, leading to massive losses for the pension schemes’ investments – just makes the case for intergenerationally fair pension reform that much more pressing.
With hindsight it’s easy to identify the reasons why the gap between older and younger workers’ pensions has widened so sharply. Increases in longevity mean companies are having to pay final salary pensions (also known as defined benefit (DB) pensions) for much longer; the pension promises made were too generous; employees did not contribute enough; government tinkering, pension scheme holidays, high management charges, the new normal of low interest rates, poor pension scheme investment returns, and past government tax raids – these have all played a part.
The harder issue is how best to level the playing field in the fairest way for all generations. The current cross-party parliamentary inquiry led by Labour MP Frank Field is, therefore, much welcomed by those of us seeking a fairer settlement between the generations. It is an opportunity to draft a new social contract that is fairer on younger generations, who are left out of the debate even though they will end up footing most of the bill.
All too often the debate is hijacked by the political rhetoric of the left or right. Any attempt to start a debate on intergenerational pension reform with many on the left is met with howls of protest, and accusations of stoking intergenerational conflict that will result in a race to the bottom for all pensions. But the argument of the political left is undermined by the “we’re alright Jack” final salary pension recipients, who have made it over the drawbridge and are sitting pretty on their index-linked final salary pensions.
Meanwhile those to the right of centre baulk at the cost for companies of running expensive final salary pension schemes, and view them as an unfair burden on business. As one finance director said when surveyed on final salary pensions, “We do not have a defined-benefit scheme. God help any company that does.” This is because the sums involved are very large indeed.
In 2015 alone companies spent £120bn covering the shortfalls in their pension scheme liabilities. According to pension analysts, BT will need to take £1bn out of the business each year until 2030 in order to redress its pension liability.
However the die is cast, the losers are invariably the young, left having to contribute more and take less – if they are lucky enough to have access to a company pension scheme – while also paying for the final salary pensions of older colleagues through lower pay, insecure employment conditions and lack of investment or expansion in the businesses they work for.
It’s also far too easy to blame the bankers and corporate tax-dodgers for the intergenerational inequity in pensions. Governments, both left and right-leaning, have failed to protect younger workers.
Where are the quality jobs offering access to in-work benefits and pensions? Governments have overseen a move towards the casualisation of the labour market, with the result that younger generations, loaded down with graduate debt and high housing and living costs, now find themselves increasingly underemployed in precarious jobs. Locked out of company pension schemes, they have also lost out on valuable pre-tax company pension contributions that help to build up a pension nest egg for the future.
This in no way excuses corporate greed. Corporate social responsibility has a part to play in balancing the interests of different generations in the workforce. Younger workers deserve the same access to pension saving as their older colleagues and should also be able to reap the rewards of their employer’s success through pension contributions. However younger workers have already taken a pensions hit in order to make pensions more affordable in the long term by moving to career-average pensions and retiring later.
Government too has worked to encourage greater pension saving among the young with the implementation of auto-enrolment in large- and mediumsized businesses. Getting the young saving is to be applauded but, unless contribution levels by both employers and employees rise substantially, young people today will be the impoverished old of tomorrow. As long as funding past pension scheme liabilities trumps contributions to today’s employees, little reform can be achieved.
It therefore seems only fair that the over-generous pensions in payment to older generations be reformed. Of course, older workers should be entitled to some financial gain from a pension they have paid into for years. They too should reap the rewards from their employer’s success. But, as the turmoil surrounding the collapse of BHS (pension deficit £571m) and inability to sell Tata Steel (pension deficit £770m) reveal, finding buyers willing to take on final salary pension scheme “entitlements” is like trying to re-float the Titanic; there may be simply too much risk of further increases in life expectancies to make salvage an attractive proposition.
It’s here that left and right need to put their ideologies to one side and ensure that “pension law and regulation can adapt to the issues of the future, rather than the problems of the past”, as stated by Field.
While it may seem unfair, final salary pension scheme members are stuck between a rock and a hard place. Accepting reform to pension entitlements by conceding that pensionsin- payment indexation is unaffordable, older workers in some of the businesses at risk could in theory make these companies more attractive to buyers, and thereby help to save more of their pension pots, while holding out for the pensions they think they were promised could put more of their pension at risk, if companies fail and the schemes are put into the Pension Protection Fund (PPF).
We have to find a third way – one that allows companies to reduce final salary pension entitlements so they are no longer, in the words of Paul Johnson, “a burden on the young”. And it will take brave politicians on all sides to grasp the nettle of DB pensions and stand up for younger generations.