The UK government has issued a pension reform Green Paper
that includes proposals that could significantly reduce retirement benefits to
millions of Britons.
The Green Paper contains proposals calling for companies to lower
their pension indexation, which is the annual rate at which they increase
payments to compensate for inflation. It is suggested that this could be done by
allowing plans to reduce indexation to the statutory minimum, or to allow plans
that base their indexation on the Retail Price Index (RPI) to switch to the
Consumer Price Index (CPI).
“There may be a case for rationalizing indexation so that
there is a level playing field across the sector,” said the UK’s Department for
Work and Pensions, which issued the Green Paper.
Although the UK Government switched its indexation from RPI
to CPI for pension purposes in 2010, some 75% of private pension plans in the UK
still base their indexation on RPI.
Because the CPI has been lower than RPI in nine of out the
last 10 years, and 22 years out of the last 27, up to 2015, allowing pension to
move from RPI to CPI would likely have a considerable impact on retirees’
benefits. According to pension
consultants Hymans Robertson, switching from RPI to CPI would take away £20,000
in benefits over an average pension participant’s life. The group also said
that moving to statutory indexation was an even more extreme measure that would
“ride roughshod over schemes trust deed and rules.”
The statutory minimum applies to defined benefit pensions (also
known as final salary pensions) accrued after April 1997, and before 2005, and which
must be increased each year by inflation capped at 5%. Pensions accrued after
2005 must be increased by inflation capped at 2.5% each year.
Despite calling for pension reform proposals, the British government
maintains a relatively positive outlook on the future of British pension funds.
While “recognizing that the system may not be operating optimally in all areas,
our main conclusion is that there is not a significant structural problem with
the regulatory and legislative framework” of defined benefit pension plans,”
said the Green Paper’s executive summary.
The Green Paper will review the powers of The Pensions
Regulator, and encourage a debate making a fair compromise between the needs
employers, members, the Pension Protection Fund, according to the Department
for Work and Pensions.
“People need to have confidence in their pension and it is
vital that they feel that they are secure,” Richard Harrington, the UK’s Minister
for Pensions, said in a release. “With recent high-profile cases highlighting
the risks inherent in defined benefit pensions, we want to ensure that these
important pension schemes remain sustainable for the future and that the right
protections are in place for members.”
After the 2008 financial crisis, record-low interest rates
and reduced expectations for future investment returns have increased estimates
of deficits in UK. pension funds, and pension liabilities have grown more than
their assets have.
“This has led to a number of commentators to declare that
there is a fundamental problem with DB schemes,” said the Green Paper. “The
Government understands people’s concerns; however, it does not recognize this
view of the pensions system,” and “we also expect the vast majority of members
to receive their benefits in full.”
Despite the government’s relatively positive view of the
state of the pension fund system, it does acknowledge that there is room for
improvement. “This Green Paper seeks to identify where there may be particular
problems or issues in order to start an informed discussion on the best way to
improve the management and oversight of the risks inherent in providing [defined
In the UK, the average defined benefit pension in payment is
a little under £7,000 per year, which is equal to approximately 25% of the
median gross earnings of full-time employees in the country, according to the
Office for National Statistics. There are approximately 11 million people
relying on defined benefit plans, which hold around £1.5 trillion of assets.
The number of Britons participating in private sector
defined benefit schemes has been in steady decline, as active memberships have fallen
by more than 50% over the past 10 years, according to the UK’s Pension
Protection Fund. And the proportion of defined benefit plans open to new
members has dropped to 13% in 2016, from 35% in 2006.
By Michael Katz