The Pensions Environment in the UK - Assignment Example

The Pensions Environment Table of Contents Introduction 3 Pensions 4 DB Pension Schemes Vs DC Pension Schemes 6 The Pension Environment 7 Company Analysis 11 Conclusion 13 References 14 Bibliography 17 Introduction It is rightly presumed by the experts of the industry that the word ‘change’ is the only constant thing in the present world of today. With the massive developments in the fields of information technology and communication process, the terms and the tricks of the trade are experiencing paradigm shifts. Most of the business sectors are initiating newer means and terms to continue their business in the changing scenario of today. The influential effect of globalisation is yet another factor that has prompted major changes in the periphery of business and profession. The factor of globalisation has reduced the geographical distances and almost wiped out the international borders among various countries in the domains of trade and finance. The economies of most of the countries are coupled and even an internal happening in a country tends to affect another economy. The reach of the customer has increased by great extent and the flow of information is at its all time high. All the factors have tremendous affects upon the economies. The financial slowdown that has been experienced in almost all of the economies since 2008 because of the sub – prime crisis, which originally originated in the United States because of the housing bubble, has abruptly affected all the major economies of the world. It has even impacted upon the sectors like pensions and the retirement benefits of the old age service persons and there is a feeling that the pensioners have been hugely affected by the recent reforms in the United Kingdom. Pensions Pensions are basically the retirement plans that the employees or the service men are entitled to receive after the active years of the professional career. It is a sort of financial assistance for the years of their service. There are various pension schemes in the industry and most of them are floated either by the employers, the government, the insurance companies and other institutions like that of trade unions or the associations of the employers. The schemes of pensions, which are also known by the names of superannuation plans or retirement plans, are primarily deferred savings of the service men in the years of service which are essentially tax – free and are paid in installments. In order to understand the overview of the environment of the pensions prevailing in the country of the United Kingdom, it is prudent to analyse the various schemes of the pensions. The pensions, as it is prevalent in the industry of the United Kingdom and many other developed nations can be classified under three broad heads namely: Employment based pensions – This is a sort of financial arrangement in which the persons gets payment from the employer as the financial benefit in the years of retirement. Most of the times, the sum of pension is calculated on the basis of the contribution from both the employer as well as employee. Social and state pensions – It is the phenomenon prevalent in many of the developed nations that includes the likes of United Kingdom, United States and France. In this case, the countries provide for funds for their citizens which they receive at the time of retirement. This type of pension is basically contribution based and therefore requires funding from the end of the recipients too. Disability pensions – The disability pensions fall under the purview of different league altogether as it is available to the incumbent only when he / she suffers from disability. It is not a regular form of pension. In this regard of analysing the pension environment at United Kingdom, it is prudent to focus upon the occupational pension schemes prevalent in the market. According to the ‘news release’ of the Office for National Statistics, Government of United Kingdom, occupational pension schemes can be defined as “Occupational pension schemes are arrangements (other than accident or permanent health insurance) organised by an employer (or on behalf of a group of employers) to provide benefits for employees on their retirement and for their dependents on their death” (Office for National Statistics, 2009). Therefore, it can be assessed that the occupational schemes are totally related with that of the service. The other important concept in this regard has been the ‘defined benefit’ pension. This stratum of the pension benefit is popularly known as the DB pensions. In this sort of pension benefit, there is clear discussion on the terms much before the time of payment of the pension that is to be provided to the recipient. The defined benefit pension is calculated on the basis of the certain pre-determined formulae. There is almost no doubt that the feature of the defined benefit pensions used to lure many of the best of the talents of the industry to the sector of service (Lazear, 1989). But the present scenario has been experiencing drastic changes in the segment of defined benefit pension schemes at least in the private sector periphery. These has created a spur and many of the experts feel that such changes are deep rooted with the financial slowdown that almost all of the economies are facing. The other important broad head in the periphery of pension is the ‘defined contribution’ pension schemes, popularly known as DC pension schemes. In simple words, in the defined contribution pension schemes, the money is contributed in to individual account of the members. The contributions are either made from the deferred salary of the employees or are directly contributed by the employers. The contributions of the DC pension schemes are generally invested in to the share markets and the respective profit (or loss, as the case may be) would be linked to the individual account. This makes the defined contribution pension schemes all the more risky and at the same time, also the probability of getting higher return increases (if and only if the market behaves good). The trends of the pension market clearly suggests that the defined contribution pension schemes are attaining increasing popularity in the present day. DB Pension Schemes Vs DC Pension Schemes Defined Benefit pension schemes are the most simplest form of pensions as it is calculated on the basis of predetermined formulae. The DB pension schemes are primarily contributed by the employer, though many a times, employees do contribute. Some of the important factors that determined the contribution include scheme asset, mortality rates, changing regulatory rates and investment returns. The DB pension schemes are the traditional one but the recent picture depicts that it is losing its popularity (TSSA, n.d.). The ‘defined benefit’ pension schemes are replaced by ‘defined contributory’ pension schemes. As discussed earlier, the contributions are invested in individual schemes. In the DC pension plans, investments are invested in the stock market and so bear high risk and the annuity rate is calculated at the time of retirement. DC pension plans are beneficial for the employers as huge portion of their cost is saved compared to DB schemes and this has contributed towards the increasing popularity of such schemes. Also, the ‘defined contribution’ pension schemes is easier for the employers to maintain if the employees are changing their jobs as those can be easily transferred. But the major disadvantage of the schemes are that nothing is fixed and all the return depends upon the market performance. After all the years of hard work, if there is financial slowdown in the year of retirement, there is high probability that the employee will lose a major portion of the expected amount (TSSA, n.d.). The Pension Environment Analysing the data available from the Government of the United Kingdom, it can be said that the number of the persons who were benefitted by the DB pension schemes in the private sector is quite large. The figure was almost 2.7 million in the year of 2007 and has been on the rise. In fact, the group, as it is classified as ‘Private sector funded DB’, is just second to the ‘Public sector unfunded DB’ which is available to the government employees. The data reveals also that 0.9 million people receives ‘Private sector funded DC’. The study of the data from another angle also reveals that in the year of 2007 out of 7.9 million members that were under the occupational pension schemes were from that of ‘Defined Benefit’. And among the 7.9 million members, one - third was from the private companies where as the remaining from two – third comprised of the public companies (Office for National Statistics, 2009). The data from the Office of the National Statistics further depicts that the figure of the contributions towards the private pension schemes had been on the rise for the five year period of 2002 to 2006. But the growth in the percentage was only around 2 % in the year of 2007 (year on year basis). In fact, the careful analysis of the data suggests that the fall in the grand total pension contributions to private pension schemes could be avoided only because of the rise in the personal pension schemes and the unfunded occupational schemes. The employer contribution was also much higher in the DB schemes ranging around 15.6 % of salary where as in DC schemes; the figure was only around 6.5% (Office for National Statistics, 2009). The prime problem for the pension in the public sector of the United Kingdom has been the huge deficits that have inculcated in the last few years. But the scenario was totally different even few years back. In fact, in the year of 2007 the private industry of the United Kingdom had reported of the trade surplus. The analysis of the monthly data from Pension Protection Fund (PPF)’s 7800 index had clearly showed that there was a surplus of hopping £ 130.4 billion. But then the same figure reduced and ultimately converted the trade surplus to trade deficit and that too of a staggering amount of £194.5 billion just within a span of one year. It presumably mandates that a huge sum of almost £ 325 billion was lost in the span of twelve months. The experts from the industry as well as the department of statistics of the UK government are of the view that it was only because of the financial meltdown all across the globe. The prime reason for such dismal performance of the pension schemes have been deep rooted in to the falling equity markets and bond yields all throughout 2008 that led to poor funding performance (Office for National Statistics, 2009). The situation has been so worse in the markets of the United Kingdom that the top companies like that of British Telecom, British Petroleum and Barclays have been compelled to either defer or terminate many of the pension benefits. Such a scenario has adversely affected the aged persons as well as the new recruits who had all the dreams and aspirations of ‘Defined Benefit’ pension’s schemes. The question in the discussion and in the debate has been that where did the entire surplus go? Many of the experts like Charles Cowling of Pension Capital Strategies and Graham Secker of Morgan Stanly were of the view that heavy dependence upon the risky financial instruments like that of equities in the investment strategy have adversely affected the pension scenario in the United Kingdom. The most of the experts of the industry points out that the loss of the trade surplus has been a function of the market as the stock prices of the major companies and the prices of the properties have taken an unexpected dip and on the contrary, the interest rates have increased sharply. But many other experts of the pension schemes of the United Kingdom had an important observation. As the question had been raised by the Financial Times, if the so – called ‘surpluses’ were really surpluses. The leading financial news paper published, “Calculations of these are based on accounting rules that do not reflect economic realities: companies are allowed to discount the cost of providing tomorrow’s pensions in today’s money at rates that are much higher than those an insurance company would use in deciding whether to take on those same liabilities. And there are no hard and fast rules about how long employers can expect their former workers to live after ­retiring, a factor that has significantly raised pension costs” (Cohen, 2009). The reasons might vary with the differing views of the experts and their analysis but the facts remain all the same and that is the pension schemes in the private segment of the United Kingdom is facing quite tough time. It can be further studied with the happenings of the major companies of the United Kingdom that had a considerable reputation in providing after retirement benefits to its employees. Company Analysis The picture of the struggling pension fiasco in the industry of the United Kingdom becomes quite evident with the study of the case of the telecom giant, British Telecom. The company has a liability of hopping £ 33 billion at the end of the March 2009 where as the company had the authorized capital of only £ 7 billion. The company also had to declare in public that the actuarial valuation for December 2008 could not be completed even by May end of 2009 because of the fact that the regulators of the pension of the United Kingdom had certain outstanding discussions with the trustees and the management of the British Telecom regarding certain valuations and underlying assumptions. The experts of the industry including that of the ‘Boots’ are of the view that BT had a very high discounting rate which was not at all feasible rate in the challenging times of the present day. Also, the management of the BT is also held responsible for the deplorable condition of the pension schemes of BT as the company never bothered to contribute towards the trade deficit in the previous years when many of the other companies had done so to be on the safer side. In this regard, John Ralfe, the former head of corporate finance of Boots was of the view, “BT’s fundamental approach since privatisation seems to be “keep betting on equities and hope for the best”. It runs a huge asset and liability mismatch – a target asset allocation of 62 per cent in equities and alternative assets – £20bn – over three times its market cap. BT is a badly run hedge fund that happens to own a phone network” (Ralfe, 2009). The detailed analysis of the financial segment of the United Kingdom with special emphasis upon the pension schemes proves that the case of the BT is not an exception. There have been other major players that include the likes of BP and Barclays, hit by the financial meltdown and had to revise the pension schemes. BP was one of the highly regarded companies in the pension arena of the United Kingdom as it always positioned within the top crust of best funded FTSE 100 groups, declared that it would close the new offering of the signing up of the new members from the April of 2010. Barclays, one of the leading financial service providers, had already declared that it would ‘close the door on the retirement benefits for the workers of the United Kingdom’. The analysts are of the view that such a decision has come as the retirement costs were shifted to the private sector. Also, many other companies like Fujitsu International UK, Rentokil and WH Smith are on the verge of declaring of withdrawing the access of the DB pension schemes to all the existing employees. The chief executive of the Barclays was courageous enough to inform that the £ 200 million of trade surplus was converted to £ 2.2 billion of trade deficit with in a year, thanks to market volatility. BP also doubted if it could maintain the promise of paying the retirement benefits to the former workers till the time of their death as the company has been badly hit and also because the life expectancy has drastically increased among the residents of the United Kingdom (Cohen, 2009). Conclusion From the above analysis of the pension scenario in the United Kingdom, it can be concluded that all the concerned parties (i.e. the employee, the company or the employer and the government) are in total fix over the huge trade deficits in the pension schemes. At the outset, it was estimated that the financial crisis would impact only in the means of increasing unemployment and bankruptcies of the financial institutions along with the stock markets. But the effect that the ‘defined benefit’ pension schemes faced because of the global slowdown, was definitely beyond expectation and calculation of the industry. The ‘defined contribution’ pension schemes that had direct link with the market performance was experiencing the worst phase. The hardest part of the ongoing scheme of things is that it is the employees who built up life time savings in the pension schemes are now compelled to revise the pension strategy and to the extent of deferment of their retirement (O’Murchu & Et Al, 2009). With the big players like BT, BP and Barclays being hugely affected in such a way, also there are not much chances of prompt recovery. References Cohen, N. 2009. Barclays consigns pension scheme to history. The Financial Times. [Online] Available at: http://www.ft.com/cms/s/0/de737fea-5072-11de-9530-00144feabdc0.html [Accessed February 22, 2010]. Cohen, N. 2009. Pensions pay the price for equity bias. The Financial Times. [Online] Available at: http://www.ft.com/cms/s/0/57dbc22e-59de-11de-b687-00144feabdc0.html [Accessed February 22, 2010]. Lazear, E. P., 1989. Pensions and Deferred Benefits as a Strategic Compensation. Working Papers. O’Murchu, C. & Et. Al., 2009. The Pensions Crisis. The Financial Times. [Online] Available at: http://www.ft.com/cms/s/0/e82a672e-4ab4-11de-87c2-00144feabdc0.html?nclick_check=1 [Accessed February 22, 2010]. Office for National Statistics, 2009. Background Notes. News Releases. [Online] Available at: http://www.statistics.gov.uk/pdfdir/ptpsfi0109.pdf [Accessed February 22, 2010]. Office for National Statistics, 2009. Private sector pension deficit nears £200 billion. News Releases. 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