50 years in pensions

According to the OECD’s most recent estimates, pension assets accounted for 80.5% of gross domestic product (GDP) in 2009 - and that figure only included private sector occupational pension schemes.

Towers Watson put the proportion as 101% of GDP in 2011, although the actuarial firm did not fully allow for personal pension plans. A more comprehensive estimate of the total pension savings in the UK, including all types of funded pension arrangements, is at least 120% of GDP or £1,800bn. And even that figure ignores unfunded public sector and State benefits, which are almost equivalent in size.

By any account, pension schemes of all types have become vastly important and influential. But that has not always been the case and a look back over the past 50 years in pensions shows how the UK pension system has grown to be not only one of the largest but also the most complex in the world.

When the workplace ruled outright

When our 50 year window into the UK’s retirement provision opens, pensions in the UK are almost entirely dominated by workplace (or occupational) schemes and the State sector.

In 1962, the basic state pension (BSP) had been in operation for just 14 years and alongside it were the forerunners to personal pension plans – retirement annuity contracts (RACs). RACs had been introduced just six years previously and were available only to workers with no access to an occupational scheme and to the self-employed.

It was the workplace pension, however, that ruled the roost. In 1963 there were 7.2m employees with private sector occupational pension schemes and nearly 4m in public sector schemes. Private sector schemes reached their peak in terms of actively contributing members in 1967 at 8.1m members - falling to 5.8m in 1987 – while public sector scheme active membership peaked in 1979 at more than 5.5m, where it has largely remained to this day.

In 1963, private sector pensions were a mix of different types: final salary, average salary, flat sums per year of service and defined contribution. But over the next decade that picture changed radically, with final salary schemes exploding in popularity until, by 1979, they accounted for more than 90% of all workplace schemes – with defined contribution making up the rest – having accounted for just over 20% in 1963.

In 1983, almost 80% of public sector workers were participating in occupational schemes, as were 43% of those in the private sector – the vast majority of those schemes being final salary. During this period the evolving State pension system went through a number of major tweaks, with the State Graduated Pension Scheme terminated in 1975 and the State Earnings-Related Pension Scheme (SERPS) introduced in its wake in 1978.

Rise of the personal pension

In 1988 a number of significant reforms were introduced that began to change this picture. Retirement annuity contracts were scrapped and replaced by the more relaxed regime of personal pension plans, allowing access to benefits at age 50, a full 10 years earlier than their predecessors.

In addition to this, compulsory membership of occupational schemes was abolished and contracting out for money purchase and personal pensions was introduced. All of this sparked a new market in personal pensions that evolved into what we have today, boosted further by the introduction of self invested personal pensions (SIPPs) in 1989.

In the early 1980s the stock market had started growing at a much faster rate than in previous decades – an expansion that was brought to a dramatic halt by Black Monday, 19 October 1987, when markets around the world crashed; the FTSE lost 26% of its value.

But the period that followed saw an equally dramatic and surprisingly consistent equity market boom that lasted until the end of the century, fuelling rapid growth in the fledgling personal pension market as individuals used the more open and expanding range of plans to either top up or replace their workplace pensions.

Attracted by the idea of greater control over their savings - and the possibility of increasing their pensions on the stock market - many transferred out of final salary schemes into personal pensions. This was also fuelled by a Government campaign that actually encouraged employees to leave occupational pensions and transfer to personal pensions with the intention of making the workforce more mobile. As we now know, that proved terribly misguided and led in part to the pensions mis selling scandal that was to hit many years later.

The regulations governing transfers from final salary schemes were tightened up in 1994, when the requirement for a detailed transfer analysis was introduced. But the boom in personal pensions lasted as long as the stock markets held out, peaking at the end of the century when 13% of all employees and 48% of self employed adults were contributing to personal pensions.

In 1999 an estimated 24% of men of working age and 12% of women were members of personal pensions; 32% of women and 36% of men were members of occupational pension schemes. At the same time, the number of actively contributing members of private sector occupational schemes was in a slow decline, falling to 5.6m members by 2000.

This trend coincided with a general beefing up of workplace pensions legislation prompted by the Mirror Group pension scandal that erupted shortly after the death of its former proprietor Robert Maxwell in 1991. The Pensions Ombudsman was set up and then in 1997 a swathe of new legislation.

This made it a criminal offence for employers not to pay contributions into their workplace scheme, introduced the minimum funding requirement (MFR), which regulated the solvency of pension funds, banned loans to employers from pension funds and introduced a number of additional requirements to be supervised by a new regulator OPRA. Despite the Maxwell scandal, however, private sector occupational pension membership was holding up.

Two crashes and the lingering death of final salary

The dawn of the millennium was the start of a 12 year period of financial and economic decline that hit all pension arrangements hard. Two stock market crashes within seven years (2001-2 and 2008-9) caused significant damage to any portfolio exposed to equities or other risky assets, as was the case for many personal and workplace pension funds.

For occupational pension schemes it was also a period of regulatory creep that saw private sector final salary schemes gradually closed down, with members pushed into money purchase schemes instead.

Many factors are cited for the now well documented demise of the final salary pension – some of which started before 2000. Firstly, and in particular, was Gordon Brown’s much criticised scrapping of advance corporation tax (ACT) relief - tax credits on share dividends - for company pension funds in 1997, which cost pension funds an estimated £100bn on aggregate.

From 2000 onwards red tape mounted up with successive revisions and amendments to pension legislation to the extent that keeping up with the latest rule changes on, for instance, calculating guaranteed minimum pensions (GMPs), frequently felt like a full time job. It was the introduction of scheme specific funding by the new Pensions Regulator in 2004/5, and the requirement for an accounting based measure of funding - marking estimates of long term liabilities to current market prices - that is generally held to be the most telling contribution to the death of final salary.

Under the previous MFR regime, pension funds could use a relatively high equity based discount rate - for instance 7% - taking account of their equity orientated investment strategy, to estimate the future costs of all their pension promises. But under scheme specific funding, trustees came under pressure to instead use a corporate bond discount rate - at the time around 5.5% - based on prices at any one day, without any ability to smooth or interpret the results.

The liabilities of most final salary scheme ballooned overnight just at a time when any actuarial deficit was becoming more noticeable on a company’s corporate balance. With particularly unfortunate timing, hard data were also being unearthed that revealed that the population was living far longer than most estimates had previously predicted, raising the cost of providing pensions even more.

And of course, these trends coincided with the middle of a lost decade for stock markets when assets were severely depleted. This triple whammy brought in an era of company pension schemes racking up highly visible and troubling deficits. The net result was that finance directors took fright, closing their final salary pensions to new joiners, and increasingly to new accrual too.

In January 2012, Shell, the last final salary FTSE100 company pension scheme to be open to new members, closed its doors. From its height of 8.1m in 1967, the number of actively contributing members of private sector occupational pension funds had fallen to just over 3m in 2009.

The National Association of Pension Funds reported in 2011 that 21% of final salary schemes were open to new members compared with 88% in 2001. By way of further comparison, membership of public sector workplace pensions actually grew during this period – from 4.4m in 2000 to 5.4m in 2009 – largely because of the expansion of the State sector and the relative generosity of their pension arrangements.

Membership of individual personal pensions also dwindled during the new century, largely as a result of diminishing returns or losses from equity based portfolios. The Office of National Statistics reports that, while 64% of self employed men were members of personal pensions in 1998/1999, the proportion had fallen to 38% by 2009, with those who stated that they no longer belonged to a personal pension tripling from 7% to 23% between 1991/2 and 2009.

But this dynamic was offset by growth in employer sponsored personal pensions; typically group personal pensions (GPPs) or group SIPPs. As companies turned away from traditional workplace pensions towards money purchase options, the idea of outsourcing the function to an insurer via individual pension contracts quickly grew in popularity.

Returns to HMRC for the 2007/8 tax year show that 7.1m people contributed to individual or employer sponsored personal pensions, of which 5.9m were employees and 1.1m self-employed.

Stakeholder makes an appearance

While traditional occupational pensions were in decline, the personal pensions market as a whole was in fine health. And personal pensions had certainly experienced both threats and opportunities from regulation during this period. In 2001, the stakeholder pension regime was launched, followed six months later by new rules, which required employers to offer staff access to a stakeholder pensions if nothing else were available.

Designed to be simple and low cost, with capped charging structures, the stakeholder regime was met by a flurry of activity as providers launched qualifying pension plans. The burst of activity temporarily breathed new life into the personal pension market, but it did not hold.

While 1.25m stakeholder pensions were sold in the first 18 months of the regime, sales were already slowing by 2003 and 82% of employer backed stakeholders had no members. The market never ground to a halt, but continued to slowly dwindle while remaining significant overall. In 2009, the Association of British Insurers estimated that 600,640 stakeholder pensions had been sold in that year, a year-on-year decline of 28%, with contributions of £995m declining by 22%. Between 2005 and 2010, Datamonitor estimates that the market for stakeholder pensions declined by 25% while that of GPPs grew by 16%.

In the midst of this period, with significant ramifications for everyone involved with pensions, the main regulatory event of the new century was A-Day. A-Day – 6 April 2006 – was the dramatically entitled and much publicised appointed day upon which a raft of new rules came into force, designed to make pensions more flexible and simpler – and, hopefully, therefore more attractive.

Among the rule changes there were provisions to allow individuals to draw a pension while working, plus permitting anyone to have a personal pension in addition to a workplace pension for the first time. But essentially this was a tidying up exercise of the eight pensions tax regimes that went before it.

Chief among the changes was the unification of rules around tax free lump sums, protected rights, triviality rules, plus some entirely new regimes - annual allowance, lifetime allowance, alternatively secured pensions and short term annuities.

While the public heard the message that pensions were getting simpler – albeit they were not quite sure how – for the pensions industry it was a huge headache. Any student of political history will agree that creating new initiatives to simplify or replace a host of previous initiatives tends to add to the problem rather than solve it; that has certainly proved true for UK pensions.

Successive Pensions Acts following 2006, attempting to rectify minor errors or introduce new principles, have left the UK with arguably the most complex pensions system in the world. In 2010, the NAPF calculated that 850 pieces of pensions regulation or legislation had been introduced since 1995 – or one a week.

In the State sector, the new century was a relatively quiet period, although it did see the introduction of the State Second Pension (S2P) replacing SERPS in 2002 and the launch of means tested pension credits in 2003. S2P was essentially a new way of calculating the same thing – the level of state pension built up through earnings – tilted this time in favour of lower earners and away from higher earners.

Pension credits, similarly, was a new way of preventing pensioners relying on State benefits from falling below the poverty line. This lull in activity was very much the calm before the storm, with the period of 2010-12 sparking some of the most dramatic debates around State pensions seen since the advent of the basic State system in 1948. As the demographic shifts with which the private pension system had been grappling for the past decade caught up with Government thinking, came the recognition in the UK and throughout much of the developed world that the cost of publicly funded pensions was no longer sustainable.

Following the financial crisis of 2008 and its ensuing economic recessions, policy makers started reviewing the promises that had been made to future generations of pensioners. The first steps were made to increase the State pension age and consultations began on downgrading pensions of most public sector workers into career average schemes, requiring higher personal contributions and a longer working life.

50 years in perspective

It can be tempting to interpret recent developments in pensions as an unfortunate shift away from State supported retirement to one where the workplace or individual bears the burden of responsibility for providing pensions, particularly in light of the next chapter to be written in 2012 – auto enrolment into workplace schemes.

But as this brief review shows, pension provision has always been firmly in the hands of the employer. While the State system has grown to become a vital support for the lowest paid in the past half century, and personal pensions have grown from nothing to rival traditional occupational schemes, the message that pensions start in the workplace remains unchanged.

What has changed, most likely forever, is the flexibility and range of options that now exist. For individual and corporate clients alike, the range of pension options is much wider than ever before, and the legislation less restrictive.

But that does not make pensions more straightforward – far from it. With evolutionary and, on occasion, revolutionary change, comes complexity not simplicity. And that is why pensions advice is more difficult and more needed now than ever before.

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