Work harder. Work longer. Save more. As the population ages and lives longer, neither state nor employer pensions can be expected to cover the cost of retirement.
Defined-benefit schemes, which pay a “final salary” based on a formula, rather than on the performance of investments such as shares, are becoming an historical anomaly. But the anomaly must be dealt with in the here and now. And manufacturers are said to have a disproportionately large number of big defined-benefit schemes compared with other businesses listed on the stock market.
Tim Thomas, the head of employment policy at EEF the manufacturers’ organisation, says: “Pension deficits only apply to defined-benefit schemes. In a defined-contribution scheme there is no covenant in which the employer promises to pay anything. So for pension scheme liabilities and deficits, we are talking about defined-benefit schemes.”
Historically, manufacturers offered defined-benefit pensions to a greater extent than other employers, but such schemes are now being closed off. However the legacies remain, and about a fifth of EEF members also still keep their final-salary pension schemes open. Manufacturing is the biggest sector running defined-benefit schemes.
“This is something to be proud of, actually,” says Thomas. “What it shows is that our members support workplace pensions.”
Clive Fortes, a partner at Hymans, an independent pensions consultancy, says: “Inevitably we see more engineering and manufacturing businesses that have got big pension schemes relative to the size of the business.
“It’s because they’ve been labour-intensive businesses, with decades of people bashing metal. Financial services firms dominate the FTSE 350 but they are not as labour-intensive: manufacturing has bigger pension liabilities with relatively smaller earnings.
“So there is a disproportionate thing where the guys who have the biggest pension liabilities can probably least afford them and those who can most afford them don’t have big liabilities.”
About 60% of the defined-benefit pension schemes in the UK are in deficit. The companies running them reach agreements with the pensions regulator that certain levels of funding are paid into the schemes over a fixed period. But problems occur because it is difficult to determine whether the liabilities of a scheme genuinely match the assets at a given time. And it’s hard to foresee how they will look in the future. Predicting economic growth or the longevity of employees is difficult. Whether a firm will have funds to service liabilities at a certain point is as hard to predict as the ups and downs of the economic cycle.
“Because people are living longer, the assumptions on which schemes were predicated are changing,” says Thomas. “While it might have been possible to predict that 90% of pensions would be paid for five years for males retiring at 65, employers are now having to look at paying them for 10 or 15 years. Longevity affects the liabilities of the pension scheme.”
The answer can be to inject large amounts of cash into the scheme to finance its future. Invensys did this when it sold off Invensys Rail and put half the proceeds – £625 million – into its pension scheme.
Fortes says that other companies, such as BAE Systems, have built “longevity hedges,” financial instruments that insure the pension scheme against the risk of many of the retirees living longer than expected. Another strategy might be to invest funds in lower-risk instruments such as government bonds rather than equities.
Some of the giant engineering firms, Fortes believes, have pensions liabilities that are twice their value on the market. “My concern is: does it impact on the relative competitiveness of these organisations compared with their peers? Are pensions preventing engineering businesses investing in UK engineering?”
He suggests, for example, that EDF might be progressing more rapidly with its plans for nuclear newbuild because of differing pensions arrangements in France.
Thomas says: “Defined-benefit schemes, for our members that support them, have to be affordable. We recognise that for many of our members they have been closed simply because they are not affordable going forward, and because of the amount of money that the employer has to put in.
“I don’t think employers closed them lightly, but because they actually threatened the survival of the business. Defined-contribution schemes are likely to be the way forward for most employees.” In these sorts of schemes, the employer and employee contribute towards buying a pension pot on retirement. But the central issue is one of longevity.
“The main problem is that we are living longer,” says Thomas. “Every single country in Europe has the same problem, whether it is the state experiencing the issue or the employer. We’re either going to work longer, and spend a lower period of our lives in retirement, or we’re going to save more.
“Or we’re going to retire at the normal age but put more into our pensions – or we’re going to accept that our pensions are worth less. Every state in Europe is looking at a combination of these factors.”
Thomas adds: “I do think we can celebrate the fact that manufacturers have historically supported final-salary pension schemes. If we do have a disproportionate liability compared to other sectors, it’s because of that historic support. And manufacturers are continuing to support workplace pensions.”
Fortes says: “The days of cradle-to-grave financial support are gone both in terms of employee aspiration and employer provision. In terms of pensions giving you a defined promise when you retire – I don’t think graduates expect it.
“There is a degree of self-reliance that is expected in terms of saving for retirement. And the days of a graduate saying ‘I have a good job with a global engineering business and I’m sorted’ are gone.”
Thomas says that employees must look to save increasingly large amounts of money to cope with decreased pension pots on retirement. Tax relief incentives to save need to be maintained, he says. And the Pensions Protection Fund (PPF), which pays out benefits in the event of a scheme’s failure, is a “very important safety net” because most of the members “will receive the majority of the retirement income they had been expecting”.
“Our members’ complaint would be that the way in which the PPF levies its funds could be calculated better because at the moment it depends on spot valuations that change over short periods.”
Court date for Visteon pensioners
Pension disputes have grown increasingly common in recent years. Perhaps the highest-profile example involves former employees of automotive firm Visteon.
The British arm of Visteon, which was spun out of Ford in 2000, collapsed four years ago with the closure of factories in Belfast, Swansea, Basildon and Enfield. Workers at these plants have since seen their pensions decimated. They claim that their terms and conditions of employment including pension provision were guaranteed by Ford at the time of Visteon’s creation. Ford denies this.
The Visteon pensioners are taking their case to the High Court. And they have attracted a high level of political support. Stephen Metcalfe, Conservative MP for South Basildon and East Thurrock, has written to Ford chief executive Alan Mulally to ask the car giant to reconsider its treatment of the Visteon pensioners.