Quantitative easing has driven UK defined benefit pensions liabilities through the roof, and problems at Tata Steel and BHS highlighted the scale of these obligations, as well as gaps in regulation. At the end of September, the total accounting deficit for FTSE 350 companies increased to £162 billion from £40 billion at the start of the year, according to Mercer. A larger sample of nearly 6,000 pension schemes tracked by the Pension Protection Fund had a deficit of £420 billion, more than double the December figure.
The FT story prompted an outcry on social media, with defenders of the status quo warning Field against tampering with ‘sacrosanct’ contracts. However, the debate started by Field is long overdue. I have argued for some time that a conditional indexation system as used in the Netherlands would have allowed investment by businesses rather than funding closed pension schemes. As in the Netherlands, retirees and deferred scheme members should be included in such a reform.
Tilting the balance in favour of reform are the new buzzwords of intergenerational fairness. Young people without inherited wealth who work in the ‘gig economy’ struggle to accumulate the assets of their parents’ generation. Defined benefit pensions – largely denied to young employees outside the public sector – exacerbate the inequality.
QE has made the annual increases in these pensions, which usually have a lower limit of 2.5 or 5 per cent, appear almost offensively generous. Applied via the notorious ‘triple lock’ to state pensions, the annual increase costs taxpayers £6 billion a year, and the burden to companies is similarly onerous. Just changing the basis of indexation from the UK retail price index to the consumer price index would reduce FTSE 100 corporate pension liabilities by £30 billion according to consultants Lane Clark & Peacock.
So should Parliament consider changing the law? Defenders of the status quo argue that any shift would be a slippery slope. They mutter about Equitable Life, where arguments of fairness were deployed in a failed attempt to break annuity guarantees to policyholders.
Such comparisons and the claims about the sanctity of pensions contracts don’t stack up. Unlike life assurance policies, defined benefit pensions are not standalone contracts but benefits attached to employment. The UK government was able to change the indexation of public sector pensions from RPI to CPI for this reason.
And in his FT interview, Field was careful not to propose a one-way change like that. As with the Dutch system, he suggested that any reduction in indexation could be clawed back if conditions later improved. Yet this mild proposal was enough to set alarm bells ringing among commentators.
If Field is to have any success with his proposal, he needs to defang the objectors’ most potent argument, which is that any reduction in pension indexation will amount to a payday for shareholders. This means more than closing loopholes in the existing rules that allowed Philip Green to cast off BHS’s pension liabilities.
Take a look at the chart of FTSE 350 pension deficits. Included with the chart are data from Factset showing the total annual income and dividends paid by members of the index (2016 figures are annualised). Despite the trend of increasing deficits, the companies are on track to pay £95 billion of dividends this year, a £30 billion increase over the past five years. Last year, FTSE 350 companies paid more in dividends than they earned in net income.
Any quid pro quo for softening pension indexation should include the ability to freeze dividends, and potentially share buybacks. And the work and pensions committee could go further: companies that invest to help the younger generation gain skills and job security should be able to fund this with pension indexation changes. This may be a pipe dream, but it would really do something for intergenerational equality.
