Should we be worried about our pensions?

Some members worry that their pension is disappearing down a black hole

The travails of BHS and its pension scheme have thrown a spotlight onto the health of final-salary pensions.

Over the years, 20,462 members of BHS staff from shop workers to executives paid into the BHS final-salary pension scheme. They will now receive less in retirement than they might have expected.

The scheme, which has a black hole, or deficit, of £571m, is now in the hands of the Pension Protection Fund (PPF) - a lifeboat organisation that steps in when companies go bust.

The BHS scheme is only one of thousands of final-salary pension schemes connected to companies across the UK - schemes which guarantee to pay a retirement income based on a percentage of your final salary every year for the rest of your life.

Latest figures from the PPF show that UK final-salary pension schemes have a collective deficit of £302bn. There are 4,891 schemes in deficit compared with 1,054 in surplus.

Some of these schemes are struggling, so should pensioners and employees be worried?

Are other final-salary pension schemes in trouble?

There is little doubt that some are struggling.

Schemes are facing "challenging times", says Joe Dabrowski, from the Pensions and Lifetime Savings Association (PLSA) - the trade body for pension schemes.

Calum Cooper, of pensions consultancy Hymans Robertson, paints a bleak picture.

"There are between 600 and 1,000 final-salary pension schemes at risk of not being able to pay the pensions of their members during their retirement. This is a very significant number and puts over a million pensions and jobs at risk," he says.

What is the problem?

There are two major causes of the black hole in final-salary pension schemes, experts agree.

The first is relatively simple - people are living for longer. That makes pensions more expensive for companies because they are paying pensioners for longer.

The second major problem is the uncertain economic outlook. Pension schemes rely on the contributions from employees being successfully invested.

There has been a long period of low interest rates and volatile markets making it difficult to make money from investing.

Mr Cooper says that final-salary schemes pumped in £30bn in the last year to try to make up for poor returns, but it does not go more than a fraction of the way to making sure things are evened up.

Rules

Bob Scott, senior partner at actuarial consultants Lane, Clark and Peacock, says another problem is "over-regulation". He says this added to the problems for businesses trying to keep schemes in good health.

"Since the 1980s, successive governments have imposed ever greater obligations on employers who offer pension schemes to their staff - such as the threat that 'surpluses' would be taxed if employers did not take contribution holidays or improve benefits," he says.

There is a wider threat, given the design of final-salary schemes, according to Tom McPhail, head of retirement policy at investment company Hargreaves Lansdown.

He says that, were a lot more schemes to get into trouble, they would become very expensive to rescue.

"The challenge is whether we accept there will be these ongoing failures, perhaps eventually putting the funding of the PPF itself under pressure," he says.

He says sometimes fulfilling existing pension promises can represent such a drain on a company's resources that the burden may become difficult to justify.

Could pension trustees and company management have foreseen the problems?

On this question, there is disagreement.

One school of thought says that pension schemes could not be expected to predict all the events and scenarios that have or have not happened, including regulation.

"If you put a frog in cold water and slowly heat it up, the frog does not perceive the danger and will eventually be boiled alive. It is the same with pensions legislation. Each additional requirement seems harmless enough, on its own, but, over time, the pension scheme (and possibly its sponsoring employer too) is cooked," says Mr Scott.

The second school of thought says that those who should oversee pension schemes were asleep on the job.

"People have been complacent for 20 years," says pensions consultant John Ralfe, suggesting companies were too ready to "bet on equities" going up sharply in value when making their investment decisions.

They have also been very slow to react to rising life expectancy, which has not been a sudden phenomenon, he says.

"They have turned a blind eye to it. They have been too slow to close down schemes to new and existing members," he says.

When should pension scheme members start to worry?

Pension schemes are linked to the performance and strength of their parent company and, as Mr Cooper points out, deficits of some schemes are larger than the actual businesses supporting them.

The fact that a pension scheme is in deficit does not mean it is in trouble. Some will have adequate plans to put them back on track and some are backed by thriving companies.

"As long as a company is generating profits there isn't a problem," says Mr McPhail. "However if you have a company like BHS where the scheme was only around 65% funded and the company is struggling to keep going, that is where the risk of benefits reductions comes to the fore."

If a company does find its pension scheme is underfunded then certain procedures must be followed.

"If the scheme is in deficit the trustees and employers must agree what is called a recovery plan - essentially a plan outlining how they plan to maintain the health and viability of the scheme - and this must be reviewed regularly with the Pensions Regulator," says Mr Dabrowski.

However, if it still fails to recover there is a safety net in place: the Pension Protection Fund, which is funded by a levy on existing schemes and ensures members receive a pension even if a company goes bust.

"If the worst happens and an employer does fail then the Pension Protection Fund is there to ensure members' pensions are protected," says Mr Dabrowski.

The likelihood is that this pension will be less generous than might have been expected when members were paying in.

What should be done now?

Most experts agree that research is needed to come up with ways the current system could be improved.

The PLSA, the association of pension funds, has set up a task force to explore the options and MPs are studying the pensions landscape.

Mr Cooper says pension scheme trustees and businesses must accept they need to work together to solve the current problems. Mr Scott says there should be a relaxation of regulation.

The last word goes to Mr McPhail, who warns that the heart of the challenge is ensuring there is a balance between protecting pensions and preserving businesses' ability to operate.

"Too little intervention leaves scheme members unprotected; too much will put grit in the engine of corporate activity," he says.