The great pensions cock-up

It must be nearly 30 years now since my boss asked me to review all the company’s standard HR letters to make sure they complied with the law and company policy. It’s the sort of project you give to a recent graduate who hasn’t the experience to do much else.

As an example, my boss showed me the standard early retirement letter. Whoever had written it had simply copied over the standard ‘congratulations on your retirement’ letter and inserted the word ‘early’. The trouble with this, my boss said, was that early retirement counted as a dismissal, even though the employee had agreed to it. “People don’t early retire,” she explained, “the company early retires them.” Therefore the letter had to contain all the usual caveats about unfair dismissal claims that would go in a normal redundancy letter.

This set me thinking. At the time, lots of people were being early retired. I began to realise that what I had at first assumed was a generous company benefit for long-serving employees was actually a way for managers to sack those they considered to be dead wood without having a difficult conversation about performance. Then I had another aha moment. Under early retirement, at least some of the payment was covered by the pension scheme, so the cost of getting rid of people didn’t hit a manager’s budget in the way that standard redundancies would. He could therefore cut his headcount and still make his numbers.

Eventually, an embarrassingly long time later I’m ashamed to say, the penny dropped. The company had been keen to push up its share price and wanted to show that it was becoming lean and mean. At that time the pension fund was fat with surplus wealth. By using some of it to cover redundancy costs, the company could make impressive cuts to its workforce without hitting its profits.

I don’t remember anyone kicking up much of a fuss about this at the time. Perhaps the unions were happy to see their members get decent payoffs and didn’t think much about the longer-term consequences. Maybe they did complain but it wasn’t considered newsworthy.

The company I worked for was far from unique though. Raiding the pension scheme to finance downsizing was not unusual during the 80s and 90s. A 1999 Cambridge University paper by Michael Pollitt noted that the headcount reductions during the privatisations of this period were achieved almost entirely through voluntarily redundancies and early retirement:

[The government] was able to compensate most of the early losers – there were very few compulsory redundancies and generous early retirement and there were voluntary severance packages for those who left privatised firms as they downsized.

Workers do not seem to have got lower salaries as a result of privatisation if they remained with the company while those who left were re-employed elsewhere in the economy (unemployment fell from 1986) or went to early retirement.

Outgoing pensions minister Ros Altman cited this as one of the reasons for the dire state of occupational pensions in a recent article on her blog:

Then we come to the role of employers. They too could not resist getting their hands on the tempting pool of assets sitting in the pension funds. They used these to hide the costs of industrial restructuring in the 1980’s and 1990’s, by giving people generous early retirement benefits (paid for by the pension scheme).

As if that wasn’t enough, companies also started taking pensions holidays, claiming that the surpluses in their schemes would be more than enough to cover the retirement costs of the future. To make things that bit worse, Nigel Lawson decided to tax pension scheme surpluses just at the point when companies should have been building them up. As  Matt Hitchens of the Intergenerational Foundation says, the term ‘pensions surplus’ was a misnomer:

What looked like surpluses were actually necessary buffers for the increased costs of scheme maturity, when there would be fewer people paying in and more taking out.

Companies were instantly disincentivised from buttressing their funding position, exactly the opposite of what should have been happening. Companies were also buoyed by the appearance of surpluses, and took contribution holidays (when they didn’t add to the pension pots) throughout the 1980s and 1990s, believing that their funding position was so strong that they could afford to do so. As it turns out, they could not.

This has left companies with huge pension deficits. According to Oxford University’s Brian Bell, it is costing employers £42 billion a year to shore up underfunded pension schemes. The amount they are having to pay to keep their pensions afloat has almost doubled since 2003. This, he says, accounts for much of the decoupling of wages from productivity and overall employee compensation. While the amount of total compensation may be keeping pace with productivity, once the pension schemes have taken their cut there is precious little left for pay increases.

This means that very little of the rise in overall compensation goes to those currently employed:

[T]he increase in non-wage compensation may provide no, or few, benefits to the currently employed. Because a substantial part of these payments are to cover deficits in pension schemes for past workers and those already in retirement, current workers benefit little from these payments.

He uses British Airways as an example:

BA spent £55 million funding a deficit in a scheme that provided a benefit to only 2.5% of their UK employees. If this money had not been required and had instead been distributed across the entire workforce as a pay increase, it would have represented a 3.8% rise. Some have ironically described the airline as ‘a pension deficit with wings’.

As the Resolution Foundation remarked, in its Intergenerational Commission report published yesterday:

The fact that younger workers have very limited access to the generous ‘defined benefit’ occupational pensions that were standard for many workers in previous generations may feel unfair in itself. But the impact runs deeper still. The circumstances that led to these schemes closing – consistent underestimates of rising life expectancy; low stock market returns; a long-term decline in interest rates; and overconfidence on the part of both companies and the government (meaning that both raided pension funds for other projects in the 1980s and 1990s) – resulted in large funding gaps. As a consequence, many firms now have to set aside large sums of money from today’s revenues to fund yesterday’s promises.

Importantly, a substantial amount of this money will form the retirement income of past workers and those already in retirement. In other words, billions of pounds each year is being extracted from the productivity (and therefore the potential earnings pots) of today’s workers to pay the retirement incomes of yesterday’s. While a similar principle underpins the State Pension – each generation’s taxes pay for the retirement of previous generations – the fact that younger workers are much less likely to hold defined benefit pensions means that this private sector generational transfer won’t be repeated.

Pension raids and contribution holidays, together with some bad planning and short-sighted tax policy, have left pension funds with a massive gap. Companies are now trying to cover this using money that might otherwise go towards pay rises. Those they employ are working to cover the cost of benefits they are unlikely to see themselves while seeing their own pay stagnate. The FT reported earlier this week that, because of the hit share prices have taken, Brexit will only make this worse.

The gains from the pension raids mostly went to swell the bonuses and share options of senior executives who have long since retired. Even the later baby boomers who came after them may not be so lucky. There is already talk of cuts to retirement incomes. According to the FT, one sixth of private pension schemes are close to insolvency and “will almost certainly end up in the Pension Protection Fund.” In other words, the liabilities will end up with the state and the pension incomes will be reduced. For those younger still, the likelihood of retiring with any sort of defined benefit scheme looks remote. Some of the middle managers who were sending out those early retirement letters in the late 80s will be coming up for retirement around now. Little did they know that every one was drilling a tiny hole in their own pension pot through which the funds would eventually leak away.

To call this the Retirement Heist, as one US journalist has described similar happenings over there, makes it sound more coherent and planned than it was, or, at least, than the British version was. What happened in Britain was as much cock-up as conspiracy, a mix of a bit of greed and a lot of short-sightedness. A few people did very well out of it. Many more benefitted from comfortable retirements, rightly because that is what they were promised. The rest of us won’t be so lucky.