EMPLOYERS PONDER PENSION CHANGES

LONDON-The probable phasing out of defined benefit pension plans would be one of the most significant results of a series of recent pension developments in the United Kingdom.

These developments include a government review of pension arrangements with the goal of establishing a new plan, a call for a new defined contribution product called a designated personal pension, and an effort to publicize companies that have not compensated those wrongly steered into private plans.

The combined effects of the developments are likely to be more far-reaching than the 1995 Pension Act, enacted mainly to tighten the regulation and administration of employer-provided pensions.

The number of defined benefit plans, called final salary schemes in the United Kingdom, likely will drop as a result of a provision in the new budget that eliminates the 20% credit on the advanced corporation tax, thereby eliminating the tax relief on stock dividends earned by pension funds (BI July 14).

That move, which took effect July 2, will cost all pension plans a combined total of 3 billion pounds ($5 billion); companies that have defined benefit plans would have

to make up any shortfall to cover their commitments to retirees.

"It is possible the budget could be the nail in the coffin for final salary schemes. It will certainly accelerate the trend toward companies adopting money purchase arrangements," said Carol Woodley, a partner who leads the pensions practice in London at financial consultants Arthur Andersen.

Arthur Andersen surveyed 56 companies, most of them major publicly traded companies, and 80% of respondents said they would review the structure of their pension plans because of the tax-credit elimination.

Two-thirds of the 56 respondents said that the changes would trigger a move toward money purchase-or defined contribution-plans.

In its survey a year ago, after the 1995 Pension Act was in place, only 20% of companies said they were planning to review their pension arrangements.

The National Assn. of Pension Funds has attacked the loss of the ACT credits for pension funds. Chairman Peter Murray called it the "biggest attack on pension provision" since World War II and said it would not only affect companies, but also millions of people.

"There can be few worse examples of short-termism than raiding people's long-term retirement savings in order to finance today's government expenditure," he added.

Another major pension event was the government's announcement earlier this month of plans to reform the pension sector, primarily by introducing a "stakeholder" group pension in the private sector as a compulsory addition to the basic state pension. The stakehold pension programs would be targeted toward those who have neither an employer-sponsored plan nor an individual private pension.

As Secretary of State for Social Security Harriet Harman acknowledged when she unveiled the wide-ranging pensions review earlier this month, the "formidable challenge" includes raising public awareness of pensions, improving the level of financial education so people understand the importance of saving for retirement, and overcoming their wariness about private pensions in light of ongoing problems with getting compensation for millions of British people wrongly advised from 1988 to 1994 to switch to underperforming private pensions from company pension plans (BI, Oct. 10, 1994).

Given that the government has allowed interested parties until the end of October to submit to the Department of Social Security their views on the pension review, details of the stakeholder pension still are widely undecided. Final proposals are expected to be published in early 1998. Parliament would have to approve the proposals, and legislation is expected to be enacted within five years, while the current Parliament is seated.

All Ms. Harman has said is that the stakeholder pensions will offer "secure, flexible and value-for-money second pensions for those who cannot join an employer's occupational scheme, whose pay is low or intermittent, and for whom personal pensions are usually unsuitable."

Also, the government hopes bodies such as employers' groups, trade unions and building societies, which are similar to U.S. savings and loans institutions, will be instrumental in distributing the stakeholder pensions to the public.

However, the government's desire to keep the costs of operating a stakeholder pension as low as possible, combined with possibly higher costs of complying with the tougher regulations likely to accompany it, have raised questions as to how profitable their operation would be for traditional insurers.

Nevertheless, the Assn. of British Insurers said it welcomes the review and hopes to participate in whatever form of new pensions emerge.

An ABI spokeswoman said traditional insurance companies might not necessarily be deterred from operating stakeholder pensions if the type of products and the number that can be sold make it worthwhile.

The NAPF supports the government's call for a pension review, and Tom Ross, an NAPF*vp, is participating by chairing a group of pensions experts reporting on the current state of pension provision in the United Kingdom.

However, while the NAPF agreed "that it would not be wise" to continue with the current system, it expressed concern that the review could fail "if it is undermined by further attacks on the tax system for pension provision."

The London-based Assn. of Consulting Actuaries, which represent's Britain's pension advisers, welcomed Ms. Harman's call for a pension review, pointing out that it had shortly before set up a number of working groups to study pensions issues similar to those she raised. However, its chairman, Paul Thornton, said any eventual solution "must recognize the rising cost burden of pensions on businesses in recent years."

He added that because of the elimination of the tax credit, "some innovative and radical proposals will be required to put back some impetus into the public's perception of long-term retirement savings as something worth doing."

Nick Wheeler, marketing director of Sheffield, England-based Hartshead Solway Ltd., Britain's largest specialized pensions administrator, also welcomes the government's pension review but said he doubts whether industrywide pension plans will flourish if pension savings ramain largely voluntary.

Mr. Wheeler said he thinks that it will require a new legal and administrative framework, particularly as the real difficulty is holding down the costs of operating such plans if membership remains voluntary.

Geoffrey Pointon, chairman and chief executive officer of London-based pension consultant Pointon York Ltd., said the pensions review needs to focus on the pension problems of smaller enterprises and their employees.

He said that generally the pension contributions of smaller firms-the 98% of U.K. enterprises employing fewer than 100 people, totaling 40% of the country's working population-"fall well below the level likely to produce adequate pensions."

Mr. Pointon said that this is particularly so in cases where firms operate defined contribution or group personal pension arrangements.

Last week, the London-based Consumers' Assn. issued pension reform proposals very similar to those the government is considering.

The Consumers' Assn. called for retention of the basic state pension and for a compulsory, second-tier pension at a contribution rate of 10%, shared between employee and employer on a basis to be decided by the government. It would be designed to deliver a pension of at least 40% of final salary.

The CA study said that most existing personal pensions are not suitable retirement planning vehicles, warning that the personal pension sales scandal could be repeated on a much larger scale if a compulsory system were to go ahead without proper supervision.

A couple days before Ms. Harman announced her pension review, the Office of Fair Trading issued a report on the pension industry that claimed that "consumer detriment is widespread in occupational and personal pensions."

The main problem with occupational pensions, according to the OFT, is that the majority of employees do not stay with one employer all their working life and thus find their pensions reduced, by up to 30% for someone who changes jobs several times.

Furthermore, the pension rights of employees retiring with defined benefit plans "are subject to a large degree of actuarial discretion, which can dramatically reduce their size." Currently available defined contribution plans suffer from inefficient and expensive selling methods, failure to achieve economies of scale and costly fund management, the OFT report adds.

The OFT recommends a new pension product, the designated personal pension.

This would be a genuinely portable, defined contribution plan, funded by the employer where an employee opted for a contribution in lieu of joining an occupational plan.

Economies of scale would keep DPP charges lower, helped by investing in a fund tracking a stock market index rather than actively trading shares, and there would be no penalties for changes in personal circumstances, according to the OFT.

Finally, this month has seen the government "naming and shaming" 24 companies that provide personal pensions that it says have not met targets for compensating people missold personal pensions from 1988 to 1994.

Most of the victims had been persuaded to move out of better-paying company pensions (BI, Oct. 10, 1994). In three years the companies have cleared up only 20,545 cases, whereas the government's timetable calls for 432,000 cases to be settled by the end of 1998.

About 1.4 million cases of persons who were ill advised on switching their pensions have been reported to date, according to the government.

The distrust in private pensions this has generated in the minds of many is one more obstacle the government faces in introducing its stakeholder pension.