EU fails in bid to force defined benefit schemes to add billions in funding, but maybe the current messy compromise is better

24th May 2013

If you are fortunate enough to be receiving a defined benefit pension or are likely to do so when you retire, you should probably consider yourself lucky writes John Lappin. The pension is usually very generous and your employer shoulders all manner of risks in terms of investment, and in terms of how long you and other scheme members live. You get a defined amount of pension related to years worked and usually linked to inflation which means it is much more generous than other sorts of scheme.

The problem is that in many cases over the two or three decades, neither employers, politicians nor regulators have appreciated just how much those pension promises would cost.

Among other mistakes, a past Conservative government decided many big schemes were well funded and gave them a contributions holiday. New Labour changed the tax rules around dividends, which many argue amounted to a tax raid of several billion a year. Past attempts to regulate the schemes particularly following the Robert Maxwell raid on the Mirror pension fund failed to ensure schemes were properly funded.

For existing schemes, that is why we constantly hear of them being billions and billions of pounds in deficit. Now the European Union is the latest to try and close the gap between assets and liabilities and even to set up a buffer. It was to include DB schemes in the Institutions for Occupational Retirement Provision directive. But at vote has at least delayed the measure amid warnings from the pension industry that it could see sponsoring employers go bust and wreck economic growth. Votes from EU member Malta were apparently crucial.

It was predicted that DB scheme sponsors could have had to find £500bn in the next few years. While employers and the government may be happy with the ‘reprieve’ what about scheme members? Well, although it is difficult to say, it is likely that many schemes could have seen their sponsoring firms pushed out of business or renewing efforts to shut up shop – or shut up a subsidiary – and hand their schemes over to the pension protection fund.

That could have meant more schemes failing on the UK lifeboat scheme, the Pension Protection Fund. For employees on low to medium salaries, at least, this functions as a significant safety net paying around 90 per cent of pension benefits up to a cap of £34,867.04 but the EU move would surely have put it under much more pressure.

Therefore, it is probably better on balance for the current messy compromises to continue where the Pension Regulator negotiates with scheme sponsors to maintain adequate funding over several years. It can get a little bit like cat and mouse but it is arguably better than a lot of schemes arriving at its door at the same.

Whatever happens, the whole sector is effectively winding down. Even strong employers, with reasonably well funded schemes, have shut them to new members and are now shutting them to existing members with HSBC one of the latest big employers to do so. Reforms to the state pension and the end of contracting out, will increase the National Insurance bill for many employers. If the DB coffin needed another nail, that is probably it.

The trend is for defined benefit to close first to new members, then to existing ones. They will usually be offered an alternative defined contribution pension so their eventually retirement will be funded by a mixture of the two. If you worried about what this means, or indeed about the state of your DB scheme, it might make sense to have it checked out with an adviser who has specific pension qualifications.

But for the DB pension, it does all seem to be too little too late to ensure adequate funding – maybe twenty years too late.

 

21 thoughts on “EU fails in bid to force defined benefit schemes to add billions in funding, but maybe the current messy compromise is better”

  1. Anonymous says:

    Great column, Shaun. Your paragraph on the CPIH measure made
    me laugh, but it’s all true. Every month of this housing price surge that goes by just underlines how unsuitable the CPIH is as an inflation measure. Its only real use is for decomposing the differences between the CPI and the HFCE deflator. It will never, or at least should never, replace the CPI as the Bank of England’s target inflation indicator.

    Of course you are right in thinking the only reason the CPI
    inflation rate is below target is because it takes no account of housing
    prices. I took a different approach from you and looked at the RPI excluding mortgage interest and council tax. It went from a 2.5% inflation rate in May to a 2.6% rate in June, which is above the 2.5% target rate for RPIX when it was the target inflation indicator. If one subtracts the 0.6 percentage points of difference between the RPI and RPIJ growth rates one still gets a 2.0% inflation rate.

    This is about as close to an inflation measure that properly includes housing prices and excludes inappropriate taxes that the ONS provides
    now. Unfortunately it is not all that close. Ignoring weighting considerations, the housing depreciation index uses exponential smoothing, so the recent house price hikes are dampened, and it excludes stamp duty. It would seem to me the smoothing of the housing price index in the depreciation component is questionable (no similar smoothing is applied to housing prices in the same component in the Canadian CPI), and excluding stamp duty is wrong. Make adjustments for both and the same series would be showing inflation of close to three per cent, much above the 2% target rate. Andrew Baldwin

    1. Anonymous says:

      Hi Andrew

      Back in the days when the structure of CPIH was being debated I attended a discussion on the subject at the Royal Statistical Society. Jill Leyland had constructed some slides which showed how the alternatives would have behaved pre credit crunch or to put it another way would they have provided a warning? The rental equivalence measure needed the equivalent of an electron microscope to tell it apart from the ordiinary CPI! Whereas adding house prices did hint at problems.

      People are free to construct a CPIH measure which fits with other parts of the national accounts. But mathematical identities and causal relationships are very different beasts….

      By the way over what period is the RPI depreciation index smoothed?

      1. Anonymous says:

        It is described in section 10.5.2 of the 2014 Consumer Price Indices Technical Manual. Exponential smoothing is used, and although the weights over the lagged terms can be changed from time to time, as now calculated, the smoothed index for month t equals 0.5 times the index for month t plus 0.25 times the index for month t-1 plus 0.125 time the index for moth t-2, etc. So conceptually it is a weighted average of an indeterminate number of terms, although as you can see the weights drop off very quickly, so better than 90% of the weight comes from the first four terms, better than 99% of the weight comes from the first seven, and 99.9% from the first 13. While the ONS manual says that the weights are reviewed from time to time, the same weights are described in the 2007 Manual. Andrew Baldwin

  2. Ian says:

    House prices double every 10 years, always have. They reflect the fact that the inflation figures provided are nothing but a joke.

    1. Anonymous says:

      Only since the 1970s: http://www.economist.com/blogs/graphicdetail/2014/04/british-house-prices

      The end of the gold standard for the US and the beginning of the end of the British empire.

      1. Anonymous says:

        the world war 1 debts preceded the 1930s crisis, and probably contributed to the empire’s downfall. But worse still was Britain’s loss of human capital on the Flanders fields and the Somme.

      2. HarryA says:

        Progrock,

        If we look debt in the economy (especially private), am sure we’ll find it follows a similar trajectory to home prices.
        Debtflation should really be a term by know…
        Harry

        1. Anonymous says:

          Exactly, the UK is simply printing money via housing as it cannot create wealth creating growth, only debt.

  3. Forbin says:

    Hello Shaun,

    It seems our inflation figures are there to make Astrology look respectful….

    Forbin

    Still waiting for the drop in corn prices to been in in my local popcorn retaier

    1. Anonymous says:

      Hi Forbin

      Corn futures have continued their falls and at US $3.74 are around 30% lower than a year ago. I guess it’s a long way to the supermarket! Meanwhile the price of a barrel of Brent Crude Oil has dropped below US $106 so perhaps it is averaging out its time above US $108…

  4. Noo 2 Economics says:

    Hi Shaun,

    We need to hope that the MMR has done enough to start taking the heat out of the housing market as at the moment I expect the next shock to emanate from the housing market if it isn’t slowed down in the next couple of months, I think Carney understands this even though he implies he’s not interested in what the housing market does.

    1. Anonymous says:

      Hi Noo2

      The problem is that the Bank of England is not only way behind the curve on this with its Funding for Lending Scheme it actively fed the house price rises. So now it wants to slow things down, what was that about stable doors and horses?

    2. Londoner says:

      I think he is either stupid or he knows it will do nothing. Since he is limiting to 15% the number of mortgages that can be approved about 4.5 times salary. Since this number, in the middle of a massive boom, is only 15% already, I would suggest he is a clown.

      1. Noo 2 Economics says:

        He also speaks of stress tests of potential mortgagees to establish they can afford to pay a 3% increase in rateshttp://www.mindfulmoney.co.uk/economy/mortgage-approvals-collapse-to-11-month-low-in-may-as-tougher-regulations-hit-home-buyers/ – this amounts to an increase of 187% in monthly payments for a 1.6% fixed rate deal lasting 2 years or a 75% increase in monthly payments for a standard 4% variable rate. These are tough numbers to meet.

        He may have noticed mortgage companies are granting cheap fixed deals with no regard to affordability in 2 or 3 years time when the deal ends and the rate reverts to whatever the standard variable rate is at that time a la 2007/2008 (I’m not saying they are doing that, just surmising) and the rate increases about 3%, that may be why he’s formalised the process. Personally, I think the fixed deal affordability test should use the rate payable in 2/3 years as the “base rate” on which to base the calculation, otherwise everyone is gambling that cheap enough money will still be around for another tranche of cheap deals to be released. Unfortunately, I don’t know what calculation, if any, the companies are doing – yet another dimension to the housing market risk due to start potentially going off in 2/3 years if the companies aren’t using the “right” formula.

        So, I still think he is worried about the housing market both in the near term property price wise and the medium term price of money wise, I certainly am.

  5. Andy Zarse says:

    Your expertise is clearly better than mine Pavlaki, but is it not the case that “lazy” retailers like Tesco are having their backsides handed to them on a plate by the Lidls and Aldis simply due to a significant sector of customers looking for better value?
    Anyway, I still struggle to see how the ONS properly calculate inflation when new outlets for the ubiquitous “tins of beans” keep popping up and this may to some extent provide an explanation as to the variance with the BRC figures.

  6. Anonymous says:

    main dealers charge about £100 per hour for servicing cars. Even little garages have horrendous rents for premises, which gets passed on to customers. This makes UK car repairs very expensive. Combined with a relatively effective MOT system – it forces Britons to renew cars frequently.

    As for the UK food market, I remember when Lidl opened near me in England, in 2003. Their sausages were much cheaper and nicer than Tescos, Asda etc. They added some much needed competition to our market. But we need to remember than the Commons Agricultural policy adds huge sums to every European consumer’s food bill. Also I read that German sausage manufacturers have recently been fined for a long running cartel. http://www.nzherald.co.nz/world/news/article.cfm?c_id=2&objectid=11293998

  7. HarryA says:

    Pavlaki,
    Re: Pack size shrinkage. A few years ago I realised that the “sharing” pouch bags offered the best value, if I was fine spreading my consumption over a few days; individual bars were getting smaller, prices had gone up and big bars were no longer that big. Today the pouches are tiny and the prices have edged up too. There’s much better value in buying a pack of 4 small ones, or getting a 3 (normal size) for £1.20 deal at a certain struggling “express” retailer.
    Choco-addict Harry

  8. Noo 2 Economics says:

    Couldn’t agree more, welcome to the world of crony capitalism consisting of monopolist and oligopolist suppliers where price fixing is the norm and lazy consumers pay the price!

  9. Pavlaki says:

    I see that Aldi and Lidl are definitely on the up as I frequently shop there myself! I no longer have the grocery retail data that I used to have but suspect that the ‘shift’ in % terms is fairly small. Any drop for Tesco or the like is a big issue for them but the absolute numbers are (relatively) small. There are discerning shoppers in the UK but there didn’t used to be anything like the number in other countries. I hope it is or has changed. I am certainly one of them!

  10. Anonymous says:

    Hi ExpatInBG

    On the subject of the expense of having a premises there was some news recently which caught my attention. It was a sports shop on the Kings Road in Chelsea which closed this spring because rent was £700,000 per year and business rates were £250,000 and they could no longer afford such bills. I had always thought of it as an expensive shop but putting it another way that was a lot of money per year in shorts, t-shirts and trainers!

  11. Anonymous says:

    Hi Harry

    I hope that you are not a fan of American brands of chocolate as price rises are on their way.

    http://www.businessinsider.com/hershey-raising-prices-july-15-2014-7

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