Wednesday, 22 August 2012

The retreat from offering new employees a defined benefit pension in the private sector is now almost complete


The headline in the Financial Times was quite unequivocal: ‘Shell ends an era with pensions retreat’ and as a trustee of the Shell Contributory Pension Fund this and other similar press reports generated a fair amount of traffic towards me. This came from pensioners who wanted to know how they were affected and, especially, from many in the pensions world who wanted to know how I felt about it. It Shell Pensions FTwas in answering a question from one pensioner friend that I realised the full extent of the misconceptions that exist about the role of the trustee. Many fund members, and quite a few others, do not realise that a trustee’s duty is only to represent the interests of the existing members of the fund and that we therefore have no role in respect of Shell’s remuneration and benefits policies for its new employees. I was able to reassure those fund members that contacted me that Shell’s proposed closure of their main UK DB schemes to new entrants (subject to the consultation process that is currently underway) does indeed not impact at all on the existing members of the fund. I was also able to reassure colleagues and friends that, in my opinion, Shell’s sponsor commitment to these DB schemes is unwavering.

Shell’s expected decision is illustrative of the changes that have taken place in the world of workplace pensions in recent times. The origin of defined benefit pension schemes in the UK in the post-war years was a key part of the offer made to attract employees but also a feature of the more paternalistic culture of the times. In recent years, however, the private sector schemes have suffered what the Association of Consulting Actuaries (ACA) has called a “seismic collapse”. At some point over the past 10 years or so the norm switched from one under which the promise of a final salary pension on recruitment was standard to one under which only a defined contribution pension was offered. And once that switch had happened there was no turning back.

In its announcement Shell said that it reviews retirement benefits “to ensure that they are competitive in the local market and meet business needs” and that the DC scheme it will offer in future will offer “a strongly competitive retirement benefit so that Shell can continue to attract and retain the talent we need”. I have no doubt that this will be the case. But the key point from an employee perspective is that in normal circumstances DC schemes can never match DB schemes in what they deliver unless the levels of contribution made are at improbably high levels. True, the more you put in the more you get out but for all but the very highest paid employees it is unrealistic to expect that a DC scheme will deliver the same retirement benefits as a DB scheme. In the far from atypical Shell case most new employees joining in 2013 and retiring in say 2048 are unlikely to enjoy anything like the pension in retirement that the employee who joined in 1978 and retires in 2013 will benefit from. Next year’s retiree will get 1/54th of his final salary for each year of service - this was the accrual rate when he joined. So if he had a salary at the national average of £26,000 on retirement his 35 years’ service will deliver him a pension of around £16,000 – roughly 65 per cent of his final earnings. To achieve a similar pension from a DC scheme that employee would have to have built up a pot of around £400,000 at current annuity rates. In 2011 money, and assuming that the employee had worked for 35 years at £26,000 per annum, he would have earned a total of £910,000 over his employment years. That means that to have enough money in his pot he would have needed to build up an amount equivalent to around 45 per cent of his aggregate pre-tax income - every year he and his employer would have had to make contributions of £11,500 per annum to fund a pot sufficiently large to allow him to retire on a pension of 65 per cent of his final salary! The ACA estimates that at present average employer contributions to DC schemes are around six per cent with employees contributing on average four per cent - a total of 10 per cent compared with the 45 per cent necessary to equal the DB benefit. You can do the maths.

The background to Shell’s decision is not, as it may have been for some other employers who have done the same, because of any current problems with its UK pension fund. Indeed only four and a half years ago Shell halted payments into the fund and took a contributions holiday because it was so heavily in surplus at that time. (This, incidentally, gives a lie to the myth that the abolition of advance corporation tax relief, which removed tax relief on share dividends, and was introduced in the first Labour Government budget of 1997, was fatally damaging to the pensions industry as a whole. Well-managed schemes, such as the Shell fund, weathered that storm pretty well.) And presently, despite the turmoil in financial markets which has affected assets adversely and the falling bond yields that have increased liabilities, the Shell’s UK fund has a technical provisions funding ratio roughly in balance. If it chose to, Shell could probably afford to continue to offer a DB scheme to new entrants but the reality is that Shell judges that this is no longer necessary. What they have done is no more than virtually every other major UK employer has done as the FT and other media fairly pointed out.

Will Shell, and all the other private sector employers who have closed their DB schemes, come to regret it? in one area I think that they may. Obviously not offering a DB scheme to new entrants means that contributions, which are currently for Shell’s UK fund at a historic high of 31 per cent of salary (the contributions holiday is long gone) this to service the accrual of existing employee members will not have to be made for these new employees. The employer contributions made to the new DC scheme are likely to be much lower. However, when the current impasse over public sector pensions is finally resolved it is certain that the public sector will continue to offer generous retirement benefits - albeit somewhat less generous than is currently the case. A DB pension in the public sector based on career average salary will surely turn out over time to be beneficial compared with any employer’s DC offer. If you had a child or a grandchild considering career options and you compared for them the certainty of a public sector pension with the lottery of a DC pension I suspect that quite a few might turn their backs on the private sector and opt for the comparatively pension rich civil service instead.

We find ourselves in a world of unparalleled uncertainty – a world in which all too many of the old assumptions no longer apply. We cannot guarantee growth or employment or probably anything like the welfare benefits that we have enjoyed for more than 60 years – and as our economic systems struggle to adapt to the new realities, as individuals we struggle as well. One thing is, however, abundantly clear. The old paradigm of cradle to grave care, be it from the state or (partly) from an employer, is disappearing. An unintended consequence of these changes and of the growing disparity in retirement benefits between the private and public sector may mean that the pension cost advantages of privatisation as opposed to public sector provision could tip the case over in the direction of private enterprise. In the past companies ‘contracted out’ to save money and hassle so that they could concentrate their efforts on the added value rather than the cost side of the P&L. To offload any concern for future pensions liability from an internal DB scheme into a third-party provided DC scheme can be seen as more of the same. Whether there is intent on the part of government to encourage transfer of activities and personnel from the public to the private sector I don’t know. But there may be a paradoxical side-effect of making public sector pension benefits more attractive than those in the private sector. That is that some current public activities may become privatised simply because the long-term employment costs are lower in the private sector because of its lower pension cost loading!

Paddy Briggs is a Member Nominated Trustee Director of the Shell Contributory Pension Fund. He writes in a personal capacity and the views he expresses are his own