Pensions: FDs’ jobs will get harder, warns NAPF chair

Companies are prematurely changing their pension schemes away from defined benefits, according to Robin Ellison, chairman of the National Association of Pension Funds (NAPF). In an interview with Insight, he said increased competition for labour could force FDs to swing back towards final salary schemes. By Tim Cooper, editor, email newsletters, CIMA.

Robin Ellison

Robin Ellison has a rare gift - to make pensions sound compelling. As an eminent pension lawyer and, for the past year and a half, chairman of NAPF, he is fearsomely knowledgeable on the subject. Even better, he is not afraid to make a point and always does it with eloquence, wit and precision. That's why we are particularly pleased Ellison will speak at this year's CIMA Annual Conference. Insight got a taster by asking him his views on the future of occupational pensions.

FRS 17 does more harm than good

One of company accountants' most pressing concerns is how to reduce the risk of volatility in their pension schemes. But Ellison said too much risk avoidance could be counterproductive: ‘Pension schemes have been enormously damaged by attempts to de-risk them as much as possible. A lot of companies are prematurely changing their schemes. Most schemes help recruit and retain workers. Otherwise they would struggle to do that. The best kind of scheme for that purpose is defined benefits (DB). The accounting rules, in FRS 17, make DB very difficult for most companies. Consequently they are converting to defined contributions (DC), which is a way of getting it off the balance sheet.

‘Across the world, and especially in the UK and the US, an understanding of the counter-productiveness of FRS 17 and similar guidance is growing. They are not doing what they intended to do, which was reflect liabilities on the balance sheet.

‘The standards say these liabilities should be reflected as though the pension scheme is wound up, which it isn’t, so it does more harm than good. They also work as if the pension is a promise, which it never was, only a best endeavour. So there are two intrinsic flaws. Changes to schemes are premature because the standards setting bodies are stepping back. In the next few years I expect a complete restructuring of FRS 17 and IAS 19. In up to four years, companies will have less stress on balance sheets from the standards.’

Impressive creativity

Ellison is nonetheless impressed with employers’ creative attempts to deal with pension liabilities. He said: ‘They are introducing hybrid schemes which are half way between DB and DC. At the moment accounting rules treat them as DB, but in the States they are beginning to say they should be DC.’

He said that, because DC doesn’t deliver what people want, we will see it swing back - not to DB, because accounting won’t allow that, but to hybrids.

In the UK, another positive effect could be the deregulation in the Department of Work and Pensions. Ellison said: ‘If it is successful - a big if - it will diminish employer risk. If it isn't successful, multinational employers will move their pension schemes to other jurisdictions where you don’t have that risk.’

Since last September the European Pensions Directive has allowed companies to establish pension schemes in any European jurisdiction.

‘For example,’ Ellison said, ‘in Sweden, employers can change the retirement age depending on longevity. So that takes out longevity risk. The Dutch allow employers to cancel indexation. That removes inflation risk. In the UK we are apprehensive about doing that. But if we want to compete internationally we will have to.’

An important issue affecting the future of occupational schemes is competition for labour. In the UK, this has been eased by European immigration. But if that were to reduce, and the competition for labour increase, pension schemes would become crucial recruitment tools again. The excuse to move to DC would be removed.

Budget rethink

Ellison said: ‘FDs will have to rethink their pension budgets in the next three to four years, because if HR directors need to recruit people on certain deals, they will have to find the money. So the pendulum may swing back. They have had a difficult time, but at least they knew the answer. They are going to have an even more difficult time because the answer is not so simple. Just to go DC is not going to meet it.’

Will the recent UK white paper on pensions make things better or worse for employers? ‘The great unknown is the impact of the national pensions saving scheme,’ Ellison said. ‘The government is hoping it might lose the next election because of this! The risk of it going wrong is pretty high. Administration, investments, underselling - you name it, some horrible thing will happen.’

Taking the politics out of pensions

Depoliticisation of pensions is becoming imperative. Ellison said that the white paper glossed over the issue of whether there will be an independent pensions commission. ‘The political pressure to invent such an organisation, rather like the Bank of England, will be irresistible. The government doesn’t want it because it has enough quangos (quasi non-governmental organisation), but it will happen,’ he said.

‘In the UK the big drivers for regulation were the Maxwell affair, and more recently, Allied Steel and Wire. What they led to was bad law and a reduction in pension provision. In Europe, there is a bigger fear of a Maxwell-type episode because they haven’t had one yet. They have viewed goings on in Britain with horror.

‘The original point of EU pension legislation was to allow companies to use their common sense in a free market. But as a consequence of these fears, the European directive has been transformed from a liberalising directive into a regulatory one - in particular in relation to solvency requirements. For example, it says “pension funds shall at all times be fully funded”. If the stock market collapsed tomorrow by 30 per cent, no company could put in 30 per cent of its value overnight. You look at it over 10-30 years.

Destructive legislation a tragedy

‘So it is destructive legislation. But you can’t explain that to a member of the European Parliament or the European Commission. That is why legislation for political reasons has become unworkable and why companies are going for DC and other forms of pension provision. It is a great shame.   

'The perception is beginning to percolate through to the EC and to domestic governments, that if they over-regulate they will kill the thing they want to love.’

All this aside, if scheme deficits reduce until they disappear around 2012, as predicted, does that mean the pensions crisis will end for companies? 'The crisis is likely to ease, unless there is another stock market collapse. In five to 10 years’ time, the headline will be different. It will be "people can’t afford to retire". That will have been driven by counterproductive regulation and that is the tragedy.'

For more information visit the CIMA Annual Conference web page.

October 2006