Bad news for final salary pensions

by Ed Bowsher on 04 June 2009  |  7 comments
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If you’re an employee with a final salary pension, I have bad news. Two more companies are downgrading their schemes. More may follow. The government should help out.

I was sorry to read this story in the FT this morning: Barclays to scrap final salary pensions.

Barclays is shutting its final salary scheme to 18,000 existing members. In other words, 18,000 people who had expected to receive a final salary scheme when they retired have now been told something different.

That's bad news for those 18,000 employees because a final salary pension would provide a guaranteed income that is a percentage of the employee's final salary. Sadly, most people these days are lumbered with a defined contribution (DC) scheme, where money is paid into a pension pot each year. Then that pot is used to buy an annuity when the pensioner retires.

I'm contributing to a DC pension but I'd much prefer a final salary scheme - if only it were on offer. That's because DC is riskier. I don't know how well stock markets are going to perform over the next 20 years and I don't know what annuity rates will be when the time comes for me to retire.

In fairness, Barclays isn't moving its employees to a conventional DC scheme. Instead it's setting up a hybrid system known as a 'cash balance' scheme. It's like a conventional DC scheme in that Barclays will pay money into an individual's pot each month. But Barclays also bears the risk of the investments underperforming as the pension builds up. If the investments don't perform as well as expected, Barclays will pay more money into the pot.

However, if annuity rates fall dramatically over the next 20 years, the employees will take the hit. Not Barclays. That spreading of risk will provide a bit of comfort to the 18,000 employees, but it's still bad news.

And Barclays employees aren't the only ones who will suffer. Morrisons has also announced changes to its final salary scheme today.

Can anything be done?

Yes, the government could do a couple of things and these measures needn't cost the taxpayer.

Final salary pensions have been damaged by several factors over the last decade. But over the last year, the main issue has been volatility in the stock market and bond prices. Companies with final salary pension schemes have to regularly monitor the health of their pension scheme. They need to check that there is enough money in the pot to meet the estimated future final salary obligations.

Falling stock markets have meant that the value of pension funds have fallen, so some companies now have substantial deficits in their pension schemes. As a result, companies will be expected to pay more money into their pension funds. What's more, the present cost of future pension obligations is measured using bond yields. So as bond yields have fallen over the last year, the pension deficits have grown larger still.

I'm not suggesting that the government should pay money into straitened pension funds. But they could make the rules more flexible. There should be more tolerance of pension deficits in bad times, while in good times, companies should have to pay in more moolah. To use the jargon: payment obligations should be 'counter-cylical.'

I just hope that MPs make this issue a priority once the current political crisis is over.

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