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MONEY BOX SPECIAL: PENSIONS IN PERIL

Presenter: Paul Lewis

TRANSMISSION 26th November 2001 2000-2030 BBC RADIO 4

LEWIS: Millions of people are paying into their company pension scheme, believing this is their guarantee for the good life in retirement. But as the post-war baby-boomers approach 60 and look forward to their golden years, the evidence is growing that, in companies big and small, these pension promises may not be kept.

MAN: I'm in a good pension scheme but everything's gone wrong - there's a shortfall, that's the famous word, there's a shortfall and I'm thinking will I ever have a pension like?

WOMAN: Any form of guarantee, as Equitable Life's situation will have shown you, is a very expensive business. I don't think any regulatory regime is going to guarantee all pensions to all people at all times.

MAN: There are immense problems out there, there are many many companies that have got fundamental pensions issues that could seriously damage their business that haven't yet been addressed.

For thirty years the advice has been the same - if the company you work for runs a final salary pension scheme join it. After a lifetime's work you'll get half or even two thirds of your pay, paid for life, guaranteed. It is the gold standard of pensions. The money comes from the fund that you and your boss have paid into for forty years. When you retire that fund pays you a guaranteed income until you die. And if the fund can't afford it, there's no need to worry - the company has to meet the promise it has made - or does it? In the public sector that promise is backed by the state. But in private companies, the situation is very different.

(Pub atmosphere�."Can I have your glasses please? "

LEWIS: A year ago, almost every glass you raised in a pub was made at the Ravenhead glass factory in St Helens, Lancashire. From beer mugs to champagne flutes, glassware had poured off its lines for nearly 160 years. With a strong order book, and a well known brand, the company seemed safe and its pension promise secure. Dave Rotherham thought so. He had worked there for 41 years, his father for even longer. It had an excellent final salary pension scheme, and at the age of 56, Dave's prospects for a comfortable retirement in a few years time seemed good. But then his dreams were shattered.

ROTHERHAM: On the fifteenth of March, on the Friday morning we walked in and he said here's your cards. And then in the next breath, your pension, you've no pension neither now. We were really sickened like you know and I see men coming out of that factory crying like, you know. Tough lads like you know. It's unbelievable, I just can't believe that they just told us like, you know, we've had this shortfall.

LEWIS: What pension were you expecting?

ROTHERHAM: Well I was expecting, as a finish worker, I was expecting a lump sum - which most companies give to their workers - and I was expecting like �100 odd a week pension, which I could probably have lived rest of me life on like, I would have managed somewhere. They reckon it could be a twenty per cent cut or there's some of my friends at work that's lost their job they think we may never get a pension.

LEWIS: Dave's experience vividly illustrates how fragile a pension promise can be. And a difficult economic climate combined with the pressure of having to guarantee pension payments is putting a strain even on some of the very biggest companies in the United Kingdom.

RUSSELL: The main area where there's likely to be problems is in large companies which have had large pension funds and then have seen that pension fund continue to grow whilst the number of employees and size of the business has shrunk. These are old economy companies such as British Airways, Pilkington, Marks and Spencers, ICI. In one of the most extreme cases, British Airways, the pension cost is at this moment in time twenty five times the level of its pre-tax profits.

LEWIS: Steve Russell who studies UK shares for HSBC bank. Ravenhead is not that big - and when, out of the blue, its Belgian owners decided to put the firm into administration the company was no longer there to meet the pension promise it had made. The administrators brought in a professional trustee Graham Pitcher, to run the pension fund. His first job was to pay the pensions of people who had already retired. When that had been done, he found there was not much left for Dave and his 200 redundant colleagues who thought they had rights to pensions in the future - so-called deferred pensions.

PITCHER: We expect that the deferreds will be about between twenty and fifty per cent.

LEWIS: Just be clear about that, they will only get between twenty and fifty per cent of the pension they were promised?

PITCHER: Yes I believe so. Hopefully it will be better and we will obviously be working on their behalf to get money in from as many sources as we can.

LEWIS: Dave Rotherham can't understand how he can have paid so much into the fund and end up with a pension that may be just a fifth of what he was promised.

ROTHERHAM: I joined the pension scheme in 1978 and they all said this is a great pension scheme. I'm getting nearer sixty and I'm thinking will I ever have a pension like? Say I don't get anything, at the end of the day there must be some law that says they must pay me a pension if I've paid to it?

LEWIS: New laws were passed to protect pension fund members after Robert Maxwell ran off with �450mn from the Mirror Group pension scheme. These laws came into force in 1995 and say that a fund and its pension liabilities have to be valued every three years. If there's not enough in the fund to meet the pension promises, the company has to put more in. It's called the Minimum Funding Requirement - or, in this world of acronyms, the MFR. Graham Pitcher, the pension fund trustee, says the shortfall was identified two years ago.

PITCHER: At the last valuation 1999, it was recognized that the fund was in deficit to the tune of one and a half million..

LEWIS: Why at that point did the company not have to put the money in?

PITCHER: Well the MFR allows you to get back to a prescribed level and the schedule of contributions which has to be put in place was put in place, but as a result of market movements and the way the MFR works that just didn't happen.

LEWIS: So a deficit of one and a half million in 1999 has grown to five and a half million now and with the winding up could grow to as much as fifteen million pounds, that doesn't seem like anybody is in there protecting the pensioners?

PITCHER: If you protect pensioners too much almost then you have industry being starved of funds and there are a lot of people out there who have been in this situation who've lost their jobs they turn around they think they can get their pension and they find that the pension fund is underfunded. Ravenhead is not unique.

LEWIS: So if the law won't protect Dave and others in final salary schemes where the company has gone bust, where might they turn? As well as introducing new laws, the Government set up a regulator to oversee company pensions. It's called the Occupational Pensions Regulatory Authority and Caroline Instance is its Chief Executive. Shouldn't she have acted when the Ravenhead pension fund didn't have enough money to meet its pension promises?

INSTANCE: I think it is a misunderstanding of what the regulation that was introduced could do. If that scheme was in deficit when the regulations came in and had up until 2007 to correct the position, when the business collapsed it could still be complying with the law but still not provide the protection that members might hope to get but isn't actually there in the laws which have been agreed.

LEWIS: So you're saying the law is inadequate to protect people in that position?

INSTANCE: I'm not saying the law's inadequate because I think there always has to be a balance between the costs involved in providing things like guarantees. Any form of guarantee, as Equitable Life's situation will have shown you, is a very expensive business, and I don't think any regulatory regime is going to guarantee all pensions to all people at all times.

LEWIS: Given that the government supports these schemes and encourages people to join them shouldn't the government act as the ultimate guarantor?

INSTANCE: The government don't act as guarantor of any private arrangement but what the government does is put a frame-work in place that ensures that those schemes at least apply consistent standards across the board. But what you also have to recognize is that getting a pension promise that was less than you expected might still be a lot better than not having a pension at all.

LEWIS: So neither the trustees nor the Pensions Regulator can protect pension scheme members - or ensure that the guarantee they have been given is enforced.

Ravenhead was one, small company in difficulties. But over the last few months four separate reports from City analysts have warned of the crisis in pension funds. Out of the one hundred biggest companies in Britain, 16 have funds which fall short of the Minimum Funding Requirement set down by the law. And Steve Russell from HSBC listed 20 companies that were most at risk from pension costs.

RUSSELL: It's likely that a company, at least one somewhere along the line, may well be sent bankrupt by the pension fund difficulties that are likely to come up at the moment. It's much more likely to be a smaller company but big companies are particularly at risk at the moment, in terms of at least their profitability. Any impact or increase in pension costs could not be coming at a worse time.

LEWIS: But some people think many of these companies have brought these pension problems on themselves. In the UK three quarters of the money in pension funds is invested in shares - equities to use the jargon. A few years ago shares enjoyed a period of unprecedented growth swelling the coffers of the pension funds. So some companies, including many of those now on the danger list, saved money by taking what is called a contribution holiday - in other words they stopped paying into the fund in the belief it had enough to meet its pension obligations. But as share prices have fallen in the last two years, those decisions have left gaps in some funds. The decision to stop paying contributions was taken on the advice of actuaries, the number crunchers who work out what a fund is worth and how much it needs to pay the pensions. Peter Thompkins is Chairman of the Institute of Actuaries. Did his members get it wrong?

THOMPKINS: No, no, I wouldn't say that we got it wrong. I think there were two things that have happened in the last five to ten years. I think if you'd asked any investment adviser what they thought interest rates, what they thought long term returns would be in the year 2001 I think few of them would have expected them to have been so low as they have become. And the other thing that has happened is that life expectancy has increased in leaps and bounds, that's something we should all be celebrating because of the advances in medical treatment and so on, but of course if you're trying to provide for a pension that's bad news because you need a lot more money in your fund.

LEWIS: But that life expectancy is right at the heart of actuarial predictions, again I say did you get that wrong, why didn't you realize life expectancy was going to grow?

THOMPKINS: Well we did and we had a study that was done about five years ago and as soon as that was done out came new statistics which is what we've been adopting and it's that that has brought through the numbers that are being seen now.

LEWIS: Peter Thompkins of the Institute of Actuaries. The new figures show that a man of 65 can now expect to live for 20 years. But even that may be an underestimate. One of the UK's biggest pension funds is the �40bn Hermes fund that looks after the pensions of BT and Consignia. It is run by Alastair Ross Goobey. And he says life expectancy is still growing faster than the actuaries predict - and that could threaten the very future of good company pensions.

ROSS GOOBEY: Over the last seven years the life expectancy of a man retiring at the age of 60 from BT has gone up three and a half years. Now in most actuarial rule of thumb the expectation was that life expectancy would go up by one year every ten years. Three and a half years in seven years is an extraordinary acceleration and the cost of that in pension fund terms is enormous and actually is really is it goes on at that speed is unbearable by any employer, and this is I think the biggest risk to the provision of final salary pension schemes in the UK.

LEWIS: Paying pensions for longer is a major drain on pension funds, already depleted by falling stock market values. If a pension fund gets into difficulties, the company behind it has to put in the money to meet the pensions promise. At the top of the HSBC list of companies at risk from their pension commitments is British Airways. The company is expected to lose around �750 million this year - but it still has to be prepared to prop up the pension scheme. Did Peter Thompkins think major companies, like BA, may find themselves in such difficulties they had to pull back on their pension promise?

THOMPKINS: Yes that could happen. If that were to be the case for example with British Airways, they'd be required to chip in the amount the government states at the moment, which isn't always adequate to provide for the pensions in full. If the company were to go out of existence, if it were to go bust, the pension debts would just be a liability along with the other creditors and they might not be paid in full. So you might find that the pensioners get their and the people who've not yet retired get eighty or eighty five per cent of their pension, it'll depend obviously on the sums that are done when the scheme is actually wound up.

LEWIS: Do you think people in pension schemes realize that?

THOMPKINS: No I don't.

(Airport noise)

LEWIS: There are already rumbles of discontent among workers at British Airways. Since the attack on America on September 11th BA has lost a quarter of its passengers. Already six hundred managers have had to take a ten per cent pay cut and all staff are being asked to do the same work for less money. Here at London's Heathrow airport many of these workers are represented by Eamon Coy, the Secretary of the GMB union, does he fear his members pensions could be cut?

COY: I think that is a very real concern. The fact that there's a cut in pay essentially means that for staff who are coming up to retirement right now, some of them here and now may have a reduction in the value of their pension. The market place is very volatile at present and I have to say that the pensions investment has been very badly affected, to the extent that British Airways presently is having to put in three times the level of contribution of their employees into the scheme in order to maintain its value. Now this is something they'll be required to do for years to come, again our real fear here is that this may not be possible. In the end does that mean that the benefits within the scheme are going to be reduced, does it mean that when somebody does come to that final day of retirement that their pension is a lot less? This is something that we desperately must avoid, if indeed in the end it meant that we have to go to government ministers for them to make up the deficit, they really do have a responsibility to the employees of British Airways which is after all our premier airline.

LEWIS: We asked British Airways Chief Executive Rod Eddington and the chairman of the Pension Fund Trustees, Derek Stevens to talk to us. They turned us down. But the airline told us it is fully committed to honouring its pension obligations - and with more than a billion pounds in the bank, at present it can afford to do so. Already it is paying more than 17% of employees' earnings into the fund - partly to make up for a previous shortfall.

A large company like BA may be able to use reserves to weather these pension storms. But smaller companies are already having to take tougher action.

(Factory noise)

Eliza Tinsley is an engineering firm in the heart of the Black Country. It makes the buckets and hydraulics for JCB and Caterpillar diggers as well as chains and ropes for the DIY market. Trading is good. But last month it told its shareholders they faced a substantial cut in their dividends. Andrew Hall is Group Chief Executive

HALL: My predecessors made pension promises to a whole group of people which we as a current management have a responsibility to honour. I wasn't confident that unless we took action now we would in the long term be capable of dealing with this. There would have been a risk to the pensioners prospects.

LEWIS: So what action have you had to take?

HALL: We concluded that we would reduce our dividend by some two thirds, the dividend reduction is in the order of one point two million pounds if it is at ultimately the level that the board have suggested, and the underfunding in the pension scheme is a moving feast day by day, but in our latest announcement we said was in the order of one point five million pounds.

LEWIS: So the whole of that one point two million, in effect over time, will go to reduce that deficit?

HALL: If the situation doesn't change, yes.

LEWIS: Tinsley is the first company in the UK to take money directly off shareholders to deal with a pension shortfall. Andrew Hall says it was almost a matter of survival.

HALL: There's a great misunderstanding out there. People think they have final salary pension promises that are going to be honoured. They will only ever be honoured those promises if the company is around to continue to fund them. There is clearly a balance that has gone on here between the interests of our shareholders, the interests of the existing employees and the interests of the pensioners.

LEWIS: And it has resulted in a considerable movement of money from shareholders to the pension fund. What's your message to those shareholders?

HALL: I think the message generally to the shareholders is that we've tackled this issue to ensure that in the long term the group has a viable future and can continue to prosper.

LEWIS: But this company chief executive wants to take another radical step. The two-thirds cut in dividends will pay for the promises made in the past. But he does not want to put shareholders in this position again. So he plans to set a date to close Tinsley's final salary scheme. The company will continue to pay into a pension scheme. But it will be something very different. The pension will not be related to pay and there will be no guarantees.

HALL: It is our intention to ensure we end up in a position where we can once and for all put a line under this from the company's perspective. We believe we could well reach a position where we say to the employees, for your future service after some given date your contributions and the company contributions would not go into a final salary scheme they'd go into a money purchase scheme. That transfer of risk, of what happens is the investment doesn't perform, then falls on the employee.

LEWIS: So they'd get a pension related to their salary for existing work so far but for future work from that date they wouldn't have a promise of any particular pension?

HALL: That's right they would have an amount of money paid into a money purchase scheme which would buy what it would buy. Clearly we would try and arrive at a rate of contribution that, all other things being equal, would attempt to mirror the benefits they would have had under a final salary scheme, and that's part of the negotiation we have to have.

LEWIS: But it wouldn't be guaranteed?

HALL: But it wouldn't be guaranteed

LEWIS: These so-called 'money purchase' pension schemes are growing in popularity as a way of removing the risk from the company and passing it to the employee. If the pension fund performs badly, the pension is lower but the company will not improve it. Many large employers have already closed their final salary pension schemes - but only to new employees. Tinsley's radical plan is to close the fund to existing employees as well. And despite Andrew Hall's promise to put enough in to give the same pension at the end, every other company has used the change as an excuse to cut the contributions it makes. A survey published on Friday by the Association of Consulting Actuaries shows them on average 6% lower, leaving employees with a smaller pension and no guarantee.

But one company thinks there is a way to preserve the guarantees of final salary schemes without asking shareholders for money.

(BBC Newsnight headline�.."Pension fund managers at Boots today delivered a dose of smelling salts to the rest of the pensions industry. They revealed they had pulled all their investments out of the volatile stock markets and put them into safe and boring government bonds"

LEWIS: Boots' decision to move its whole �2.3 billion pension fund out of shares tore up fifty years of pension fund investment practice. By putting the whole amount into bonds, which are basically IOUs from governments or companies and provide a regular, guaranteed income, it avoids the ups and downs of the stock market. The bonds Boots chose are certainly safe. And John Ralfe, Boots' Head of Corporate Finance, says the investment returns will meet the pensions promise even in the most extreme circumstances.

RALFE: If the company goes bust, and we hope it won't but if the company goes bust, there should be enough money, in the pension fund there should be the appropriate cover and there should be the right structure of assets to be able to meet all pensions.

LEWIS: So the pensioners themselves and the pension fund members should feel more secure?

RALFE: That's correct it significantly increases the security for pension scheme members in the Boots pension fund.

LEWIS: Do you think other companies will have to follow you?

RALFE: Some companies have moved quite a sizable chunk, say twenty per cent, and ICI made that public two or three weeks ago, that trend may well continue. And of course it's worth saying that they heavy equity investment of UK pension funds is peculiar to the UK, and if you look at the US for example there's a much higher weighting in bonds, or you look back to the UK of not that long ago, thirty or forty years ago, again there was a much higher level of bonds. So one shouldn't assume that the current equity/bond split is God given.

LEWIS: It may not be God given - but Boots is overturning an absolute principle of UK pension fund investment - to put most of the money into shares, also known as equities. Using shares as the bedrock of pension fund investments is attributed to one man - George Ross Goobey. Fifty years ago as the actuary to the Imperial Tobacco pension fund he went the opposite way to Boots and moved Imperial's investments out of bonds and into shares - with such spectacular results that all other schemes followed suit. And today, three quarters of all pension fund investments are in the stock market, despite the risks. George Ross Goobey died two years ago. His son Alastair, continues the family tradition running the forty billion pound Hermes pension Fund. Does he believe it is time to follow Boots and rethink the investment strategy that has worked so well for half a century?

ROSS GOOBEY: No I don't, may be I would say that wouldn't I? The funding of the schemes for most employers will still be bearable. A very well financed company with lots of cash flow will be prepared to take the volatility risk because they will still believe that shares will give better returns over the long term than bonds and cash. And this is the important thing, the Boots example for instance, it is not driven by the view that equities will not do better than bonds, shares will not do better than bonds. I don't think I've seen anybody suggest that shares are going to do worse than bonds over the long term, and if that's true it's going to be more expensive to provide the same pension benefit by investing in bonds than it will be by investing in equities. So for most sponsors if they can afford the volatility risk then buying equities for their pension fund is still the right thing to do.

LEWIS: It is this volatility of equities - the fact that the value of shares goes down as well as up - that causes problems for funds which have to pay people fixed pensions. In the last year as the stock market has fallen, pension funds have lost an average 20% of their value and the companies that back them are getting nervous. And now another problem lurks on the horizon. You can't talk to anyone in the pensions business today without hearing the phrase FRS17 - it may sound meaningless, but it sends a shiver down the spines of Finance Directors everywhere. It is an accounting standard - which states that from 2003 company accounts will have to show the true cost to the company of the pension promises that have been made. In itself it doesn't alter the financial health of companies. But it does make the pension liabilities visible for the first time. And that will encourage companies to cut dividends, rein back on investment, or eat into reserves to make their figures look sound to investors. Steve Russell, Equity Strategist at HSBC, says final salary schemes, where benefits are defined, will suffer.

RUSSELL: We think FRS17 is likely to be the final nail in the coffin of defined benefits schemes. It puts even more onus and risk onto the providing company with no corresponding benefit so it's likely to see an increasing number of companies close down or at least shut off to new members, those defined benefits schemes and shift into defined contribution.

LEWIS: This new openness about the cost of defined benefit or final salary schemes, together with a weak stock market, and longer life, seem to put guaranteed pensions in peril. But what do the pension funds themselves say? All company schemes belong to the National Association of Pension Funds. Its chairman is Peter Thompson. Will the millions of people in final salary company schemes get the pensions they have been promised?

THOMPSON: I don't think the danger of pensions promises not being kept is any greater now than it always has been. There's always a risk in a company final pay scheme or any company pension scheme that if the company goes bust the pension fund might not be sufficient to meet the promises that have been made. That's no different now from what it has been in the last twenty years.

LEWIS: And do you not think there are more schemes now in danger of not being able to meet those promises than there were a few years ago?

THOMPSON: I'm not aware of any evidence that there are more schemes in trouble now than there were a few years ago.

LEWIS: So despite the fall in the stock market, despite the difficult financial position of some major companies, you're saying things are really no worse than they were five years ago?

THOMPSON: A final pay scheme relies on the backing of the employer to meet the promises made in the rules of the final pay scheme. If the employer goes out of business the amount that is available to meet those promises is the amount held in the fund at the time that the employer goes bankrupt. The employee's best security is the continuing survival of the employer and its ability to continue to pay the amounts into the fund that are needed.

And Alastair Ross Goobey, manager of the �40bn Hermes fund, believes that most pensions will be paid as promised.

ROSS GOOBEY: Intuitively you might have thought that the year 2001 has been disaster for pension schemes, aren't they all going to be terribly underfunded as a result of what's happened in the market place? I think there is a lot of alarmism easily made by 'pension funds lose another �20 billion in value'. It just is not true. Pension schemes are long term schemes where what you get out of it depends on what happens in thirty or forty years not in six months.

LEWIS: But many of the big schemes are only surviving by cutting back on their pensions promises and half of all the people in company schemes work for small firms. They just have to hope that no-one has called time - as they did at Ravenhead Glass - when it comes to meet their pensions promise.

ROTHERHAM: The promises were made that I was in a good pension scheme and it would last, the pension scheme. It would give you a good pension at the end of the day and I'm finding out now that it's not giving me a good pension. It has put me and a lot of people off pensions for forever and more.